Be 4

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Shareholders as stakeholders

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Learning pointsThe nature of shareholder relations to the corporationAnalysis of the rights and the duties of shareholdersSpecific ethical problems and dilemmas arising in the relationbetween companies and their shareholdersThe ethical implications of globalization on shareholderrelationsThe notion of shareholder democracy and the accountabilityof corporations t o their shareholders and other stakeholdersThe differences in shareholder roles and corporategovernance in various parts of the worldPerspectives on how shareholders can influence corporationstowards sustainability

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Shareholders as stakeholders-Understanding corporate governance

Crucial problem is separation of ownershipand control leading to

Peculiarities of corporate ownership ± Locus of control- control lies in the hands of directors orthe board. The shareholders have at best indirect orimpersonal control

± Fragmented ownership- many shareholders, scattered andhardly consider themselves as owners ± Divided functions and interests- shareholders are

interested in profits while managers seek growth

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R ights and duties in

firm-shareholder relationsR ights 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)

misconductImportant Note: R ights do not include the right to acertain amount of profit and dividend- they dependupon the decision of other shareholders in the GBmeeting and on the able skills of the managers.

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R ights and duties in

firm-shareholder relations- contDuties of managers ± Duty to act for the benefit of the company short term

financial performance and long term survival of thecompany. Managers have considerable amount of discretion even though shareholders decide this aspect

± Duty of care and skill managers seek to achieveprofessionalism

± 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/ whichinvestment projects are good for the company

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R elationship between shareholders

and managersSeparation of ownership and management well defined rights of shareholders and illdefined duties of managers- leading todelicate relationship focusing the need tounderstand corporate governance.

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Corporate governance

Corporate governance constitute-It is the process by which shareholders seek to ensurethat their corporation is run according to theirintentions 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 contributeto the achievement of stakeholder goals inside andoutside the corporation

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Corporate governance- a principal-agentrelation

Principal:

Shareholder Agent:

Manager Seeks remuneration, power, esteem etc .

Seeks profits, rising share price, etc.

Features of agency relations

1. Inherent conflict of interest

2. Informational asymmetry(Theprincipal has limited knowledge of actions/accounting aspects andgoals of the agent)

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Corporate governance- a principal-

agent relation- contConflicting interests:Shareholder is a principal who contracts

management as an agent to act in theirinterest within the boundary of the firm. Itleads to conflict of interests---

Conflicts in purpose and interests Managers may withheld crucial informationcoming to the notice of shareholders

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Definition of corporate governance

Corporate governance is the acceptance bymanagement of the inalienable rights of shareholders as the true owners of the corporation

and of their own role as trustees on behalf of theshareholders. It is about commitment to values,about ethical business conduct and about making adistinction between personal and corporate funds inthe management of a company -

-Narayana Murthy ( R eport of the SEBI Committeeon Corporate Governance February 8, 2003)

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Shareholder and stakeholder relations: Different frameworks of corporategovernance globally

O wnershipstructure

Dispersed Concentrated,interlocking patternof ownershipbetween banks,insurancecompanies, andcorporations

Concentrated ineither the hands of owner-mangers or the wider circle of employees in joint-stock corporations

Highly concentrated;recent tendency tomore dispersedownership

Highly concentratedin state-ownedcompanies; fairlyconcentrated inprivate enterprises

Highly concentratedownership by familyowned businessgroups; wave of privatization since1990 has reducedstate ownership

Ownershipidentity

y Individualsy Pension andmutual funds

y Banksy Corporationsy State

y O wner-managersy Employeesy State

y Familiesy Foreign investorsy Banks

y Statey Familiesy Corporations

y Family ownedbusiness groupsy State

Changes inownership

Frequent Rare Frequent, butdecreasingtendency

Traditionallyextreme rare, butrecently changing

y Rare, butincreasinglydynamic

y Rarey Increasinginfluence of foreigninvestors

Goals of ownership

y Shareholder valuey Short term profits

y Sales, marketshare, headcounty Long termownership

y Profit for ownersy Long termownership

y Long termownershipy Growth of marketshares

y Long termownershipy Sales, marketshare

y Long termownershipy Profit for owners

Boardcontrolled by

y Executivesy Shareholders

y Shareholdersy Employees

y O wner-managersy O ther insiders

y O wnersy O ther insiders

y O wnersy Party/the state

y O wners/shareholders

Keystakeholders

y Shareholder y O wnersy Employees (tradeunions, workscouncils)

y O wnersy State

y O wnersy Customers inoverseas markets

y O wnersy Guanxi-network of suppliers,competitors andcustomers (mostly)in overseas markets

y O wnersy Customers inoverseas markets

Anglo-Americanmodel

RhenishCapital ism

Russia India China Brazil

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Ethical issues in corporate

governance1. Executive accountability and controlA separate body of people (board of directors) that supervisesand 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(sincethey alone can act in the principal s interest)

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Executive accountability and

control- contIn order to ensure principal interest, Non-executive boardmembers 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.

IMPOR TANT NOTE:MANYTIMES THEY BELONG TO SAME PEER GROU P AS EXECUTIVE DIRECTORS OR

ARE THEMSELVESIN EXECUTIVE ROLES ELSEWHERE, OR HAVE BEEN IN SUCH ROLE IN THE PAST.

HENCE COM PLETELY NEUTRAL AND INDEPENDENT APPROACH IS Q UITE DIFFICULT

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governance- cont2. Executive remunerationFat 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 significantincreases (since the market for executive talent is global)

± Board often fails to reflect shareholder (or other stakeholder) interestsNOTE : FROM THE PERSPECTIVE OF JUSTICE THEORY IT IS UNETHICAL. Interests of

Shareholders (profit maximization) is jeopardised if executives take fat salaries.

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governance- cont3. Ethical aspects of mergers and acquisitionsAcceptable if it results in transfer of assets to owner who usesthem more productively

Central concern is managers who pursue interests notcongruent with shareholder interests due to

± Executive prestige vs. profit and share price interest of shareholders

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Ethical aspects of mergers and

acquisitions- contHostile takeovers when one or a group of shareholderspurchase majority stake (often secretly) against the wishes of the board. It is possible because some shareholders want tosell their stocks

Ethical concern iswhen other shareholders do not want to sellIntentions and consequences of mergers and acquisitions aresuspect

asset stripping by splitting the take over companies/ sellingcertain parts of the company and significantly playing with theproperty rights of other shareholders- Restructuring anddownsizing (example, CEO of GE, Jack Welch acquired large manycorporations and built GE)

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Ethical aspects of mergers and

acquisitions- contEthically-questionable options by managers(Carroll and Buchholtz, 2008)

Greenmailing to secure post-merger job Managers, inorder not to lose jobs after the take over, send greenmail secretly to the potentially hostile party and offerto buy back the shares for the company at a pricehigher than the market price. By this managers securetheir jobs using corporate money

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governance- cont4. Insider Trading and Speculative StocksSpeculative faith stocks ± dot-com bubble (companies not made any profit but worth billions

on the market)

± Ethical issue: bonds based entirely onspeculation without always fully revealingamount of uncertainty

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Insider Trading and Speculative

Stocks- contInsider 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 unfairadvantage to a fewMisappropriation of property insider uses valuable information of thefirm which they have no right to accessHarm to investors and the market- harmful to ordinary investors andconfidence in the market is shakenUndermining of fiduciary relationship- managers, instead of acting for theinterests of shareholders will be acting for insiders which is ethicallywrong

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

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governance- cont5. The ethics of private equity and hedge fundsR ise of private equity and hedge funds aggravate issues

around transparency and shareholder controlMost 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

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Shareholders and globalisation

Globa l financia l markets are the total of all physical andvirtual (electronic) places where financial titles in thebroadest sense (capital, shares, currency, options, etc.) aretraded worldwide

Ethical issues raised:1. Governance and control- difficult due to deterritorialization,

example, the sub-prime lending in US had repercussions in othermarkets with less scope for government control

2. National security and protectionism- example, what happens if

sovereign wealth funds are used to gain control in companies acrossthe globe that own strategic assets such as ports, airports, defenceetc?

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Shareholders and globalisation-

contEthical 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 bywithdrawing capital by foreign investors taking advantage of the notso strong regulatory regimes.

5. Space for illegal transactions- In less regulated markets, there is amplescope for transactions leading to drug trafficking, money laundering,illegal trade of weapons etc.

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R eforming corporate governance

around the globeMain 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

± R ights 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, 2002for bringing

about significant changes in corporate governance

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

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The Tobin Tax and Robin Hood tax

Effort to impose control on global markets through TobinTax 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 suddenlywithdrawn, countries have to drastically increase interest rates fortheir currency to still be attractive

± Robin Hood Tax - was aimed against the wealthy and the revenue tobe used for the benefit of poorer citizens

Two main problems with tax: ± Global enforcement- sometimes difficult ± Does not differentiate between desirable and undesirable transactions

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Combating global terrorism and

money launderingDeregulated social spaces are invitation for illegal financialactivitiesMoney laundering estimated up to $1.5 trillion/year

IMF recommendations for banks to help reduction of moneylaundering ± Know your customer ± Prevent criminals getting control of key positions in banks ± Identifying and reporting unusual/suspicious transactions ± R aise general awareness for regulators and staff

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Shareholders as citizens of the

corporation1. Shareholder democracyIdea that a shareholder of a company is entitled to have a sayin corporate decisionsSupported by legal claim based on property rightsCan shareholders be a force for wider social accountabilityand performance?- example, 60% shareholders of Shell votedout the remuneration package of the BoardThree issues to consider: ± Scope of activities- Corporations are answerable to financial

performance and also the interest of stakeholders. These are to bewell defined for the consumption of shareholders

± Adequate information- Managers have to provide information aboutsocial audit for the benefit of shareholders to take informed decisions

± Mechanism for change- Can be done by integrating CS R in to theCorporate decision making structure and through shareholder activism

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corporation- cont2. Shareholder activismBuy 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

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corporation- cont3. Socially responsible investment(S R I) Ethica l investment is the use of ethical, social

and environmental criteria in the selectionand management of investment portfolios,generally consisting of company sharesInvestors can exclude shares of undesiredcompanies and embrace shares of ethicallymanaged companies

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Ethica l investmentExamples of positive and negative criteria for ethical investment

Negative criteriaAlcoholic beverages production andretailAnimal rights violationChild labour

Companies producing or trading withoppressive regimesEnvironmentally hazardous productsor processesGenetic engineeringNuclear powerPoor employment practicesPornographyTobacco productsWeapons

Positive criteriaConservation and environmentalprotectionEqual opportunities and ethicalemployment practices

Public transportInner city renovation and communitydevelopment programmesEnvironmental performanceGreen technologies

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Main concerns with S R I 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 SR

I fund- exampleEnron, Bank of America etc

Strong emphasis on returns: ± Usually, SR I fund managers screen for performance first, then select

using ethical criteria

± Firms taking longer-term perspectives and thus sacrificing short-termprofitability therefore unlikely to be included

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Shareholders as citizens of thecorporation- cont

4. Shareholding for sustainability- shareholdersaligning investment decisions to sustainability

The Dow Jones Sustainability Group IndexBest-in-class approach since it includes a family of indices

that embrace companies which meet certain social,environmental and ethical standardsFamily of indexes comprising different markets and regions

(e.g. Asia-Pacific sub-index added in 2009)--- continued

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Shareholders as citizens of thecorporation- cont

Companies accepted into index chosen along followingcriteria: ± Environmental (ecological) sustainability ± Economic sustainability

± Social sustainabilityCriticisms 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

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Summary

Principal-agent relationship between managers andshareholdersDivergent interests and unequal distribution of

information institutionalises some fundamentalethical conflicts in governanceShareholders have considerable opportunities to usetheir power over supply to influence corporations to

behave more ethicallyShareholders can play a role in driving corporationstowards enhanced sustainability by their investmentdecisions at the stock market

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Thank You

Could be reached [email protected]

Be 4

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