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 stakeholders-
Understanding 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: Agent:

Shareholder Seeks remuneration, power, esteem etc. 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 principal-
agent 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 unchallengeable 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 Rhenish Russia India China Brazil
model Capitalism
Ownership Dispersed Concentrated, Concentrated in Highly concentrated; Highly concentrated Highly concentrated
structure interlocking pattern either the hands of recent tendency to in state-owned ownership by family
of ownership owner-mangers or more dispersed companies; fairly owned business
between banks, the wider circle of ownership concentrated in groups; wave of
insurance employees in joint- private enterprises privatization since
companies, and stock corporations 1990 has reduced
corporations state ownership

Ownership  Individuals  Banks  Owner-managers  Families  State  Family owned

 Pension and  Corporations  Employees  Foreign investors  Families business groups
identity  State  State  Banks  Corporations  State
mutual funds

Changes in Frequent Rare Frequent, but Traditionally  Rare, but  Rare

decreasing extreme rare, but increasingly  Increasing
ownership
tendency recently changing dynamic influence of foreign
investors

Goals of  Shareholder value  Sales, market  Profit for owners  Long term  Long term  Long term
 Short term profits share, headcount  Long term ownership ownership ownership
ownership  Long term  Growth of market  Sales, market  Profit for owners
ownership
ownership shares share

Board  Executives  Shareholders  Owner-managers  Owners  Owners  Owners/

 Shareholders  Employees  Other insiders  Other insiders  Party/the state shareholders
controlled by
Key  Shareholder  Owners  Owners  Owners  Owners  Owners
 Employees (trade  State  Customers in  Guanxi-network of  Customers in
stakeholders
unions, works overseas markets suppliers, overseas markets
councils) competitors and
customers (mostly)
in overseas markets
 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

matching 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
2. 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?
 Shareholders and globalisation-
cont
• 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 Positive criteria

• Alcoholic beverages production and • Conservation and environmental
retail protection
• Animal rights violation • Equal opportunities and ethical
• Child labour employment practices
• Companies producing or trading with • Public transport
oppressive regimes • Inner city renovation and community
• Environmentally hazardous products development programmes
or processes • Environmental performance
• Genetic engineering • Green technologies
• Nuclear power
• Poor employment practices
• Pornography
• Tobacco products
• Weapons
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