Shareholders and Business Ethics

Module-9
 Crucial problem: separation of
ownership and control

• Peculiarities of corporate ownership

– Locus of control
– Fragmented ownership
– Divided functions and interests
• Locus of control: control of owned property does not exist in
the hands of owner. Lies in the hands of directors or board or
other committee. Shareholders have indirect and impersonal
control over their poverty.

• Fragmented Ownership: individual themselves considers to be

the owner.

• Divided Functions and interest: not necessarily the same as the

one who controls company. Shareholders might seek profit
while manager might 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

Does not include, Right to certain amount of profit or dividend.

• Duties of managers
– Duty to act for the benefit of the company- 2 LEVELS: short term
financial performance & long term survival of company. Shareholders
decide which level the company want to perform.
– Duty of care and skill- managers seek to achieve most professional
and effective way of running the company.
– Duty of diligence- expected level of active engagement in the
company affairs.
 Corporate governance
Corporate governance definition
Various rules, processes and structures that enables shareholders to exercise
directions and control over managers. It ensure that ‘their’ corporation’s run
according to their intentions.
It includes processes of goal definition, supervision, control, and sanctioning.
It includes all actors who contribute to the achievement of stakeholder goals
inside and outside the corporation

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 Corporate governance: a principal-agent relation

Apple scandal:
• The biggest scandal to hit Apple in recent years is undoubtedly the
‘batterygate’ of December 2017.
• This started when a Reddit user reported that a software update had
reduced the performance of their iPhone but that this had corrected
itself when they replaced the battery. This post led to a lot of press
coverage, with some commentators suggesting that Apple was trying to
force users to upgrade by deliberately slowing devices as they aged. Tim
Cook issued a statement on the matter a week after the news broke,
confirming that the software was designed to throttle performance but
claiming that the intent was only to prevent unexpected shutdowns,
which could affect devices with older batteries. The company offered a
discount on battery replacements as a gesture of goodwill for those
affected.
 Corporate governance: a principal-agent relation

Facebook scandal
• Facebook’s biggest scandal hit in March 2018, when the Guardian and New York
Times reported that a firm called Global Science Research had harvested data
from millions of Facebook users in 2013 – without their explicit consent.
• This was possible because a previous version of Facebook’s privacy policy had
allowed apps to access data about users’ friends – such as their name, birthday
and location. This had enabled Global Science Research to gather information
about 87 million Facebook users even though only around 30,000 people had
actually used their app. These details were later sold to Cambridge Analytica, who
used it to create highly-targeted ads to encourage users to vote for Trump and
Brexit.
• The furore surrounding this scandal was so serious that Mark Zuckerberg was
called to answer questions in front of Congress in the US.
 Corporate governance: a principal-agent
relation
• Shareholder is a principal who contracts
management as an agent to act in their
interest within the boundary of the firm.
• The Framework shows relation between firm,
manger and shareholder
• Olympus (2011) CEO – Michael Woodford -$1.5 billion
• 140 years old UK Co-operative bank (2013) – 4.6 billion customers
• GM (2014) Recalled 2.5 millions cars- ignition switch 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 Continental Russia India China Brazil
model European Model
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

identity  Pension and  Corporations  Employees  Foreign investors  Families business groups
mutual funds  State  State  Banks  Corporations  State
Changes in Frequent Rare Frequent, but Traditionally  Rare, but  Rare
ownership decreasing extreme rare, but increasingly  Increasing
tendency recently changing dynamic influence of foreign
investors

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

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 overseas markets suppliers, overseas markets
councils) competitors 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’
 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
Independent auditors
 Executive remuneration
• ‘Fat cat’ salary accusations
– E.g. average CEO salary in Britain £6.5m (highest CEO salaries in 2008:
Europe, €77m, USA, $84m)
– 2012 CEO-to-worker compensation ratio in USA: 350-1. 84-1 in UK, 28-
1 in Europe.
– 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 – KPMG of 700 mergers found that 17% only created real value for
shareholders.

• Ex. HP and eBay

• The first rule to keep in mind is that joining two companies’ ethics and
compliance programs is about more than paper and numbers. It is also about
culture.

• Culture-such as values, work ethic, business practices, leadership style and

company mission.

• A second rule to keep in mind throughout the process is that ethics and
compliance issues, including cultural issues, need to be addressed as they arise.

• Hostile takeovers – concern when shareholders do not want to sell

• Intentions and consequences of mergers and acquisitions

– Restructuring and downsizing – GE s Jack Welch ( Neutron Jack in Wall st)
• M&A success lies not in the completion of financial
transactions but in post acquisition Human
integration, organizational commitment and job
performance.

• Problem may arise because of mismatch: one firm

heavily invest in employees and other focus on
shareholders or customers??

• 3 key factors: People, process and systems. People

issue made a difference to the success of merger.
 Root of ethical problems in M&A
• Shareholder value- who are your shareholders?
• Same for stakeholders
• Conflict between profitability and ethics
• Greenmail or greenmailing is the action of purchasing
enough shares in a firm to challenge a firm's leadership with
the threat of a hostile takeover to force the target company to
buy the purchased shares back at a premium in order to
prevent the potential takeover.
 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
– High Frequency Trading (HFT)
• 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 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
 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
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
– Unfair competition with developing countries
– Space for illegal transactions
 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
 The Tobin Tax
• Effort to impose control on global markets “Tobin Tax” – tax
on foreign currency transactions
– Not make impossible but delay international currency speculation
– ‘Robin Hood Tax’- The Robin Hood tax is a package of financial
transactional taxes (FTT) proposed by a campaigning group of civil
society non-governmental organizations (NGOs). Campaigners have
suggested the tax could be implemented globally, regionally or
unilaterally by individual nations.
• Two main problems with tax:
– Global implementation
– Does not differentiate between desirable and undesirable transactions
Combating global terrorism and money laundering

• 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

• 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

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
 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
• 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
 Alternative Models II: Social Purpose
Corporations

• Social Purpose Corporations:

– “A type of corporation that is legally required to
pursue a social purpose in addition to its commercial
goals.”
– Also known as “Benefit Corporations”, which have
more specific legal requirements:
• Must pursue a general public benefit in addition to profit.
• Must consider their effects on a full range of stakeholders.
• Must produce an annual benefit report detailing their
performance in addition to their proposed public benefit
against a third party standard.