Shareholders as stakeholders

Learning points
The nature of shareholder relations to the corporation Analysis of the rights and the duties of shareholders Specific ethical problems and dilemmas arising in the relation between companies and their shareholders The ethical implications of globalization on shareholder relations The notion of shareholder democracy and the accountability of corporations to their shareholders and other stakeholders The differences in shareholder roles and corporate governance in various parts of the world Perspectives on how shareholders can influence corporations towards sustainability

Shareholders as stakeholdersUnderstanding corporate governance

Crucial problem is separation of ownership and control leading to Peculiarities of corporate ownership
Locus of control- control lies in the hands of directors or the board. The shareholders have at best indirect or impersonal control Fragmented ownership- many shareholders, scattered and hardly consider themselves as owners Divided functions and interests- shareholders are interested in profits while managers seek growth

Rights and duties in firm-shareholder relations

Rights of shareholders The right to sell their stock The right to vote in the general meeting The right to certain information about the company The right to sue the managers for (alleged) misconduct Important Note: Rights do not include the right to a certain amount of profit and dividend- they depend upon the decision of other shareholders in the GB meeting and on the able skills of the managers.

Rights and duties in firm-shareholder relations- cont

Duties of managers
Duty to act for the benefit of the company short term financial performance and long term survival of the company. Managers have considerable amount of discretion even though shareholders decide this aspect Duty of care and skill managers seek to achieve professionalism Duty of diligence refers to the expected levels of active engagement in company affairs To manage the property of shareholders in their best interests- which strategies/ which products/ which investment projects are good for the company

Relationship between shareholders and managers

Separation of ownership and management well defined rights of shareholders and ill defined duties of managers- leading to delicate relationship focusing the need to understand corporate governance.

Corporate governance
Corporate governance constitute
-It is the process by which shareholders seek to ensure that their corporation is run according to their intentions which includes processes of goal definition, supervision, control, and sanctioning -In the narrow sense it includes shareholders and the management of a corporation as the main actors -in a broader sense it includes all actors who contribute to the achievement of stakeholder goals inside and outside the corporation

Corporate governance- a principal-agent relation

Seeks profits, rising share price, etc.

Principal: Shareholder
Seeks remuneration, power, esteem etc.

Agent: Manager

Features of agency relations 1. Inherent conflict of interest 2. Informational asymmetry(The principal has limited knowledge of actions/accounting aspects and goals of the agent)

Corporate governance- a principalagent relation- cont

Conflicting interests: Shareholder is a principal who contracts management as an agent to act in their interest within the boundary of the firm. It leads to conflict of interests--Conflicts in purpose and interests Managers may withheld crucial information coming to the notice of shareholders

Definition of corporate governance

Corporate governance is the acceptance by management of the inalienable rights of shareholders as the true owners of the corporation and of their own role as trustees on behalf of the shareholders. It is about commitment to values, about ethical business conduct and about making a distinction between personal and corporate funds in the management of a company-Narayana Murthy (Report of the SEBI Committee on Corporate Governance February 8, 2003)

Shareholder and stakeholder relations: Different frameworks of corporate governance globally

Anglo-American model Ownership structure
Dispersed

Rhenish Capitalism
Concentrated, interlocking pattern of ownership between banks, insurance companies, and corporations y Banks y Corporations y State Rare

Russia
Concentrated in either the hands of owner-mangers or the wider circle of employees in jointstock corporations y Owner-managers y Employees y State Frequent, but decreasing tendency y Profit for owners y Long term ownership y Owner-managers y Other insiders y Owners y State

India
Highly concentrated; recent tendency to more dispersed ownership

China
Highly concentrated in state-owned companies; fairly concentrated in private enterprises

Brazil
Highly concentrated ownership by family owned business groups; wave of privatization since 1990 has reduced state ownership y Family owned business groups y State y Rare y Increasing influence of foreign investors y Long term ownership y Profit for owners y Owners/ shareholders y Owners y Customers in overseas markets

Ownership identity Changes in ownership Goals of ownership Board controlled by Key stakeholders

y Individuals y Pension and mutual funds Frequent

y Families y Foreign investors y Banks Traditionally extreme rare, but recently changing y Long term ownership y Growth of market shares y Owners y Other insiders y Owners y Customers in overseas markets

y State y Families y Corporations y Rare, but increasingly dynamic y Long term ownership y Sales, market share y Owners y Party/the state y Owners y Guanxi-network of suppliers, competitors and customers (mostly) in overseas markets

y Shareholder value y Short term profits

y Sales, market share, headcount y Long term ownership y Shareholders y Employees y Owners y Employees (trade unions, works councils)

y Executives y Shareholders y Shareholder

Ethical issues in corporate governance

1. Executive accountability and control
A separate body of people (board of directors) that supervises and controls management on behalf of shareholders Dual structure of leadership
executive directors: are actually responsible for running the corporation non-executive directors are supposed to ensure that the corporation is being run in the interests of the shareholders

The central ethical issue here is the independence of the supervisory, non-executive board members(since they alone can act in the principal s interest)

Executive accountability and control- cont

In order to ensure principal interest, Non-executive board members should be
Typically drawn from outside the corporation No personal financial interest in the corporation Appointed for limited time Competent to judge the business of the company Sufficient resources to get information Appointed independently- by shareholders directly in GB or through appointment by the supervisory board. IMPORTANT NOTE:
MANYTIMES THEY BELONG TO SAME PEER GROUP AS EXECUTIVE DIRECTORS OR ARE THEMSELVESIN EXECUTIVE ROLES ELSEWHERE, OR HAVE BEEN IN SUCH ROLE IN THE PAST.

HENCE COMPLETELY NEUTRAL AND INDEPENDENT APPROACH IS QUITE DIFFICULT

Ethical issues in corporate governance- cont

2. Executive remuneration
Fat cat salary accusations
E.g. average CEO salary in Britain 6.5m (highest CEO salaries in 2008: Europe, 77m, USA, $84m) E.g. average annual pay rise for CEOs 11% CEO increases outstrip shareholder returns

Ethical problems with executive pay:

Performance-related pay leads to large salaries that cause unrest within corporations (since salaries include shares and share options) Influence of globalisation on executive pay leads to significant increases (since the market for executive talent is global) Board often fails to reflect shareholder (or other stakeholder) interests NOTE: FROM THE PERSPECTIVE OF JUSTICE THEORY IT IS UNETHICAL. Interests of
Shareholders (profit maximization) is jeopardised if executives take fat salaries.

Ethical issues in corporate governance- cont

3. Ethical aspects of mergers and acquisitions
Acceptable if it results in transfer of assets to owner who uses them more productively Central concern is managers who pursue interests not congruent with shareholder interests due to
Executive prestige vs. profit and share price interest of shareholders

Ethical aspects of mergers and acquisitions- cont

Hostile takeovers when one or a group of shareholders purchase majority stake (often secretly) against the wishes of the board. It is possible because some shareholders want to sell their stocks  Ethical concern is when other shareholders do not want to sell Intentions and consequences of mergers and acquisitions are suspect asset stripping by splitting the take over companies/ selling certain parts of the company and significantly playing with the property rights of other shareholders-Restructuring and
downsizing (example, CEO of GE, Jack Welch acquired large many corporations and built GE)

Ethical aspects of mergers and acquisitions- cont

Ethically-questionable options by managers (Carroll and Buchholtz, 2008)
Greenmailing to secure post-merger job Managers, in order not to lose jobs after the take over, send green mail secretly to the potentially hostile party and offer to buy back the shares for the company at a price higher than the market price. By this managers secure their jobs using corporate money

Ethical issues in corporate governance- cont

4. Insider Trading and Speculative Stocks
Speculative faith stocks
dot-com bubble (companies not made any profit but worth billions on the market)

Ethical issue: bonds based entirely on speculation without always fully revealing amount of uncertainty

Insider Trading and Speculative Stocks- cont

Insider trading
Insider trading occurs when securities are bought and sold on the basis of material non-public information (Moore 1990) Ethical arguments (Moore, 1990)
Fairness inequalities in the access to information results in unfair advantage to a few Misappropriation of property insider uses valuable information of the firm which they have no right to access Harm to investors and the market- harmful to ordinary investors and confidence in the market is shaken Undermining of fiduciary relationship- managers, instead of acting for the interests of shareholders will be acting for insiders which is ethically wrong

Insider trading can erode trust in the market in the long term; hence its illegality

Ethical issues in corporate governance- cont

5. The ethics of private equity and hedge funds
Rise of private equity and hedge funds aggravate issues around transparency and shareholder control
Most general concern:
There are no longer many obligations for public information about a company once it has been taken private route

Hedge funds do not have to report to regulators in the same way as other investment firms
Don t even have to report fully to own investors Suggestion is this lack of transparency hides systemic risk

Shareholders and globalisation

Global financial markets are the total of all physical and virtual (electronic) places where financial titles in the broadest sense (capital, shares, currency, options, etc.) are traded worldwide Ethical issues raised:
1. Governance and control- difficult due to deterritorialization, example, the sub-prime lending in US had repercussions in other markets with less scope for government control National security and protectionism- example, what happens if sovereign wealth funds are used to gain control in companies across the globe that own strategic assets such as ports, airports, defence etc?

2.

Shareholders and globalisationcont

Ethical issues raised:
3. Speculation Global financial markets encourage speculation on ulterior motives. 4. Unfair competition with developing countries example, encouraging speculation in developing economies, encash the boom by withdrawing capital by foreign investors taking advantage of the not so strong regulatory regimes. 5. Space for illegal transactions- In less regulated markets, there is ample scope for transactions leading to drug trafficking, money laundering, illegal trade of weapons etc.

Reforming corporate governance around the globe

Main tool in Europe, USA and Asia is reforming codes of governance, dealing with:
Size and structure of board Independence of supervisory or non-executive directors Frequency of supervisory body meetings Rights and influence of employees in corporate governance Disclosure of executive remuneration General meeting participation and proxy voting Role of other supervising and auditing bodies

US passed Sarbanes-Oxley Act, 2002 for bringing

about significant changes in corporate governance

King Report on Corporate Governance in South Africa, 1994 is also towards this direction

The Tobin Tax and Robin Hood tax

Effort to impose control on global markets through Tobin Tax a tax on foreign currency transactions
The tax on foreign exchange transactions was devised to cushion exchange rate fluctuations. The idea is very simple- at each exchange of a currency into another a small tax would be levied - let's say, 0.5% of the volume of the transaction. This dissuades speculators as many investors invest their money in foreign exchange on a very short-term basis. If this money is suddenly withdrawn, countries have to drastically increase interest rates for their currency to still be attractive Robin Hood Tax - was aimed against the wealthy and the revenue to be used for the benefit of poorer citizens

Two main problems with tax:

Global enforcement- sometimes difficult Does not differentiate between desirable and undesirable transactions

Combating global terrorism and money laundering

Deregulated social spaces are invitation for illegal financial activities Money laundering estimated up to $1.5 trillion/year IMF recommendations for banks to help reduction of money laundering
Know your customer Prevent criminals getting control of key positions in banks Identifying and reporting unusual/suspicious transactions Raise general awareness for regulators and staff

Shareholders as citizens of the corporation

1. Shareholder democracy
Idea that a shareholder of a company is entitled to have a say in corporate decisions Supported by legal claim based on property rights Can shareholders be a force for wider social accountability and performance?- example, 60% shareholders of Shell voted out the remuneration package of the Board Three issues to consider:
Scope of activities- Corporations are answerable to financial performance and also the interest of stakeholders. These are to be well defined for the consumption of shareholders Adequate information- Managers have to provide information about social audit for the benefit of shareholders to take informed decisions Mechanism for change- Can be done by integrating CSR in to the Corporate decision making structure and through shareholder activism

Shareholders as citizens of the corporation- cont

2. Shareholder activism
Buy shares in company for right to speak at the AGM
Voice concern and challenge the company on allegedly unethical practices Possibility of broad media attention by disrupting the meeting

Issues:
Only an option for reasonably wealthy individuals

Shareholders as citizens of the corporation- cont

3. Socially responsible investment(SRI) Ethical investment is the use of ethical, social and environmental criteria in the selection and management of investment portfolios, generally consisting of company shares Investors can exclude shares of undesired companies and embrace shares of ethically managed companies

Ethical investment
Examples of positive and negative criteria for ethical investment Negative criteria
Alcoholic beverages production and retail Animal rights violation Child labour Companies producing or trading with oppressive regimes Environmentally hazardous products or processes Genetic engineering Nuclear power Poor employment practices Pornography Tobacco products Weapons

Positive criteria
Conservation and environmental protection Equal opportunities and ethical employment practices Public transport Inner city renovation and community development programmes Environmental performance Green technologies

Main concerns with SRI movement

Absence of quality of information
Most information provided by firms only and is difficult to verify

Too inclusive
90% of Fortune 500 firms are held by at least 1 SRI fund- example Enron, Bank of America etc

Strong emphasis on returns:

Usually, SRI fund managers screen for performance first, then select using ethical criteria Firms taking longer-term perspectives and thus sacrificing short-term profitability therefore unlikely to be included

Shareholders as citizens of the corporation- cont

4. Shareholding for sustainability- shareholders
aligning investment decisions to sustainability

The Dow Jones Sustainability Group Index

Best-in-class approach since it includes a family of indices that embrace companies which meet certain social, environmental and ethical standards Family of indexes comprising different markets and regions (e.g. Asia-Pacific sub-index added in 2009)

--- continued

Shareholders as citizens of the corporation- cont

Companies accepted into index chosen along following criteria:
Environmental (ecological) sustainability Economic sustainability Social sustainability

Criticisms of index:
Depends on data provided by the corporation itself Questionable criteria used by index Focuses on management processes rather than on the actual sustainability of the company or its products

Summary
Principal-agent relationship between managers and shareholders Divergent interests and unequal distribution of information institutionalises some fundamental ethical conflicts in governance Shareholders have considerable opportunities to use their power over supply to influence corporations to behave more ethically Shareholders can play a role in driving corporations towards enhanced sustainability by their investment decisions at the stock market

Thank You

Could be reached at nagaraja.rao@alliance.edu.in