Crane and Matten Business Ethics (3rd Edition)

Chapter 6

Shareholders and Business Ethics

Lecture 6

Overview
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: 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 corporations 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

Corporate governance: a principalagent 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

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

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) 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 (Carroll and
Buchholtz, 2008)

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 (Moore 1990) Ethical arguments (Moore, 1990)
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

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 intermediarys 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
Dont even have to report fully to own investors Suggestion is this lack of transparency hides systemic risk

Shareholders and globalisation

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 National security and protectionism Speculation (see slide on Tobin tax) Unfair competition with developing countries Space for illegal transactions (see slide on money laundering)

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

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

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

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 Single-issue focus No financial concerns Seeks confrontation Seeks publicity Ethical investment Multi-issue concerns Strong financial interest Seeks engagement Avoids publicity
Source: Sparkes (2001)

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

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

Ethical investment

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

Ethical Investment
Top 10 stocks held in SRI funds in emerging market firms, 2009
Position 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. Company Petrobras (Brazil) Samsung Electronics (South Korea) China Mobile (China) Taiwan Semiconductor (Taiwan) Teva (Israel) Vale Do Rio Doce (Brazil) America Movil (Mexico) Gazprom (Russia) Posco (Korea) Ambev (Brazil) Industry Oil and gas Consumer electronics Mobile phone provider Electronics Pharmaceuticals Mining Mobile phone provider Oil and gas Steel Alcoholic beverages (e.g. Brahma)
Source: Eiris, 2009

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
(See Vogel, 2005)

Shareholding for sustainability

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