Shareholders and Business Ethics

• Prepared for class discussion

• By
• Prof.S.Suryanarayanan
 Shareholders as stakeholders
Separation of ownership and control
• Peculiarities of corporate ownership
• Locus of control
• Fragmented ownership
• Divided functions and interests
 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
• Certain residual rights in case of the corporation’s liquidation

• Duties of managers
• Duty to act for the benefit of the company
• Duty of care and skill
• Duty of diligence
 Corporate governance
Corporate governance definition
--Describes the process by which shareholders seek to ensure that ‘their’
corporation is run according to their intentions. It 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
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• Corporate governance is the set of processes, customs, policies, laws, and
institutions affecting the way a corporation (or company) is directed,
administered or controlled. An important theme of corporate governance is
the nature and extent of accountability of particular individuals in the
organization, and mechanisms that try to reduce or eliminate the principal-
agent problem.
 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
Shareholder and stakeholder relations: Different frameworks of corporate governance globally
Anglo-American Rhenish Capitalism Russia India China Brazil
model ( Continental
European Model)
Ownership Dispersed Concentrated, Concentrated in either Highly concentrated; Highly concentrated in Highly concentrated
structure interlocking pattern of the hands of owner- recent tendency to state-owned ownership by family
ownership between mangers or the wider more dispersed companies; fairly owned business
banks, insurance circle of employees in ownership concentrated in private groups; wave of
companies, and joint-stock corporations enterprises privatization since
corporations 1990 has reduced
state ownership

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

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

Changes in Frequent Rare Frequent, but Traditionally extreme  Rare, but increasingly  Rare
ownership decreasing tendency rare, but recently dynamic  Increasing influence
changing of foreign investors

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

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

controlled by  Shareholders  Employees  Other insiders  Other insiders  Party/the state shareholders

Key  Shareholder  Owners  Owners  Owners  Owners  Owners

stakeholders  Employees (trade  State  Customers in  Guanxi-network of  Customers in
unions, works councils) overseas markets suppliers, competitors overseas markets
and customers
(mostly) in overseas
markets
 Ethical issues in corporate governance
• Executive accountability and control (I)

• A separate body of people 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
• Anglo-Saxon model: single-tier board
• European model: two-tier boards, lower tier = executive directors,
and upper tier = ‘supervisory board’
 Executive accountability and control (II)

The central ethical issue here is the independence of the supervisory, non-
executive board members
No directly conflicting interests ensured by:
• 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
 Executive remuneration

• ‘Fat cat’ salary accusations

• E.g. average CEO salary in Britain £6.5m (highest CEO salaries in 2008: Europe, €77m, USA,
$84m) in India Rs 60 crores for CEO,SUN TV networks. ( Kalanidhi Maran; his wife also
earns similar salary )
• 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
• Influence of globalisation on executive pay leads to significant increases
• Board often fails to reflect shareholder (or other stakeholder) interests
 Ethical aspects of mergers and acquisitions

• Acceptable if results in transfer of assets to owner who uses them more

productively
• Central concern is managers who pursue interests not congruent with
shareholder interests
• Executive prestige vs. profit and share price
• Two ethically-questionable options for managers
• Seduced with golden parachute for cooperation
• Greenmailing to secure post-merger job
• Hostile takeovers – concern when shareholders do not want to sell
• Intentions and consequences of mergers and acquisitions
• Restructuring and downsizing
 The role of financial markets and insider
trading

• 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
• Insider trading occurs when securities are bought and sold on the basis of material non-public
information
• Ethical arguments
• Fairness
• Misappropriation of property
• Harm to investors and the market
• Undermining of fiduciary relationship
• Insider trading can erode trust in the market in the long term; hence its illegality
• Ethical dilemma 6
 The role of financial professionals and market
intermediaries

Two crucial professions: Accountants & credit ratings agencies

• Task is to provide a ‘true and fair view of the firm – i.e. bridge informational
asymmetry
• Five main problematic aspects of financial intermediary’s job:
• Power and influence in markets
• Conflict of interest (e.g. cross-selling)
• Long-term relationships with clients
• Size of the firm
• Competition between firms (danger of corner-cutting)
 Private equity and hedge-funds

Rise of private equity and hedge funds exacerbate 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
• 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
 Global financial markets

• 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:
• Governance and control—no Government is entitled to govern the global market; collapse of
Icelandic Banks
• National security and protectionism—Sovereign Wealth Funds investing in strategic assets.
• Speculation (see slide on Tobin tax)
• Unfair competition with developing countries
• Space for illegal transactions (see slide on money laundering)
•DEFINITION of 'Speculation'

•The act of trading in an asset, or conducting a financial transaction, that has a

significant risk of losing most or all of the initial outlay, in expectation of a
substantial gain. With speculation, the risk of loss is more than offset by the
possibility of a huge gain; otherwise, there would be very little motivation to
speculate. While it is often confused with gambling, the key difference is that
speculation is generally tantamount to taking a calculated risk and is not
dependent on pure chance, whereas gambling depends on totally random
outcomes or chance.
The Tobin Tax
• Effort to impose control on global markets “Tobin Tax” – tax on foreign currency
transactions
• Not make impossible but impede international currency speculation
• ‘Robin Hood Tax’
• Two main problems with tax:
• Global enforcement
• Does not differentiate between desirable and undesirable transactions
•Private equity is a source of investment capital from high net worth individuals
and institutions for the purpose of investing and acquiring equity ownership in
companies. Partners at private-equity firms raise funds and manage these monies
to yield favorable returns for their shareholder clients, typically with an investment
horizon between four and seven years.
Hedge funds are alternative investments using pooled funds that may use a
number of different strategies in order to earn active return, or alpha, for their
investors. Hedge funds may be aggressively managed or make use of derivatives
and leverage in both domestic and international markets with the goal of
generating high returns (either in an absolute sense or over a specified market
benchmark).
• Back to slide 14
Reforming corporate governance around the
globe
• Some important shortcomings in present systems of
governance in many countries
• Main tool in Europe is 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
• Legal basis and power of these codes varies dramatically
• And the crisis in late 2000s has seen deeper state involvement
• US response – Sarbanes-Oxley
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

• back to
slide15
 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?
• Three issues to consider:
• Scope of activities
• Adequate information
• Mechanism for change
Two approaches to ‘ethical’ shareholding

Stakeholder activism Ethical investment

Single-issue focus Multi-issue concerns

No financial concerns Strong financial interest

Seeks confrontation Seeks engagement

Seeks publicity Avoids publicity

 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:
• Gets involved with ‘the enemy’
• Only an option for reasonably wealthy individuals
 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
 Ethical investment
Examples of positive and negative criteria for ethical investment

Negative criteria Positive criteria

• Alcoholic beverages production and retail • Conservation and environmental
• Animal rights violation protection
• Child labour • Equal opportunities and ethical
employment practices
• Companies producing or trading with
oppressive regimes • Public transport
• Environmentally hazardous products or • Inner city renovation and community
processes development programmes
• Genetic engineering • Environmental performance
• Nuclear power • Green technologies
• Poor employment practices
• Pornography
• Tobacco products
• Weapons
 Ethical Investment
Top 10 stocks held in SRI funds in emerging market firms, 2009

Position Company Industry

1. Petrobras (Brazil) Oil and gas

2. Samsung Electronics (South Korea) Consumer electronics
3. China Mobile (China) Mobile phone provider
4. Taiwan Semiconductor (Taiwan) Electronics
5. Teva (Israel) Pharmaceuticals
6. Vale Do Rio Doce (Brazil) Mining
7. America Movil (Mexico) Mobile phone provider
8. Gazprom (Russia) Oil and gas
9. Posco (Korea) Steel
10. Ambev (Brazil) Alcoholic beverages (e.g.
Brahma)
 Main concerns with SRI movement

•Quality of information
•Most information provided by firms and is difficult to verify
•Dubious criteria
•See table in previous slide
•Too inclusive
•90% of Fortune 500 firms are held by at least 1 SRI fund
•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
 The Dow Jones Sustainability
Group Index

• ‘Best-in-class’ approach
• Family of indexes comprising different markets and regions (e.g. Asia-Pacific sub-index added in 2009)
• 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
 Rethinking sustainable corporate ownership:
alternative models?
• Government ownership:

• Part of the landscape in many parts of the world. Resurgent in the

wake of the late-2000s financial crisis (esp. banks and cars).
• Family ownership
• Families may have longer-term goals, but may not treat
stakeholders any better than MNCs
• Co-operative ownership
• Hybrid businesses, not owned by investors or managers
• Owned and democratically controlled by workers or customers
• Not set up to make profit but to meet the needs of members
• Spanish Mondragon co-operative has made a striking contribution
to sustainability while staying highly profitable
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
 Ethical dilemma : Who cares whose shares?
• Ethical issues:
• Conflict of interest
• Loyalty to the employer
• Friendship and loyalty to a friend
• Compliance with laws of the stock market
• Self-interest in acting upon insider information
• Stakeholders
• Company
• Frediie’s clients
• Freddie as investment banker
• Freddie as a shareholder
• You as a share holder
• Potential buyers of company’s stock
• Options to make decision
• Not to sell, not to tell Freddie
• Tell Freddie, but advise him not to tell his client
• Not to tell Freddie, but sell stocks yourself
• Tell Freddie and allow him tell his clients
•