The improvement of Governance - Case Study Example

Emphasising the role that al shareholders can proactively play in promoting good governance among listed companies, The Walker Review on the role of corporate governance in the banking crisis, says that,: ‘Early initiative under the rubric of preventive medicine will in many cases save substantial time and money at a later stage’ Walker Review, Section 5.29 p. 70. Critically evaluate this statement in the light of empirical evidence on shareholder activism in the UK and elsewhere, like the US. Also, comment on whether you think the latest Stewardship Code for institutional investors is likely to be effective in increasing shareholder engagement and good governance in the investee companies in UK. 1. Introduction The expansion of globalization in markets worldwide has led firms to alternate their strategies in order to compete their rivals; in many cases, conflicts have been developed among a firm’s strategic planners regarding the criteria used for the key strategic decisions. The problem seems to be more severe in case of large corporations – where the conflict of interests of stakeholders can be extended. Current paper focuses on the examination of the role of shareholders in promoting good corporate governance policies; the use of practices, such as the shareholder activism is explored at the level that they reflect the efforts of shareholders to promote their interests and even to keep their control on the organization – in the case of institutional investors. It is concluded that existing shareholder practices, including shareholder activism, can be proactive in setting good corporate governance policies. However, the success of these efforts is also related to the active support by the state; the Stewardship Code for institutional investors is among the key legislative texts that reflect the willingness of the state to protect the interests of shareholders in corporations in Britain – similar assumptions can be developed for USA where the use of shareholder activism is considered as a key strategy for enhancing the rights of shareholders and achieve a stable organizational growth – through the promotion of communication and cooperation across the organization. 2. Shareholder activism – definition and characteristics Shareholder activism is developed within modern organizations in order for the interests of the shareholders to be protected; more specifically, shareholder activism is a term used to express not a series of actions that resist to specific organizational activities but a behavioural framework aiming to promote the interests of shareholders – referring to all type of shareholders since they have all important role in the corporate governance – through their right of voting (Hendrikse et al., 2004, p.71); the role of shareholder activism as a key part of the organizational strategic planning can be understood by referring to the activities which the specific behavioural framework includes: ‘a) direct negotiation with management, b) use of the media for targeting the firm, c) cooperation with other shareholders in the achievement of the targets set’ (Hendrikse et al., 2004, p.71). In accordance with Gillan and Starks (1998) shareholder activism represents ‘a continuum of responses to corporate performance’ (Gillan and Starks, 1998, p.13). In other words, shareholder activism is a strategic tool of pressure against a firm’s top management aiming to secure the protection of the interests of shareholders – in the form of specific measures that are beneficial for the shareholders or in the form of avoiding activities that could have negative impact on the shareholders’ interests. Sturm presents a definition on the shareholder activism (2009); in accordance with the above definition shareholder activism is a term used in order to describe ‘the proactive efforts to change firm behavior or governance rules’ (Black, 1997, 3 in Sturm, 2009, p.4); through a similar approach, shareholder activism could be used in order to show ‘the exercise of influence by shareholders on corporate managers to achieve individual objectives’ (Sturm, 2009, p.5). From a similar point of view, Visser et al. (2010, p.5) note that shareholder activism is used in order for the concerns of shareholders to be discussed with the management; however, this definition does not reveal the actual priority of shareholder activism, i.e. the interests of shareholders and not of other stakeholders. Moreover, the above definition can lead to the assumption that the practices used in the context of the shareholder activism can be limited to general discussions and negotiations with management while this is not the case; in fact, shareholder activism can lead shareholders to use the media for exercise pressure on the management – this sense of pressure is a necessary element of the shareholder activism which is differentiated at this point to the common discussions in the context of the general board meetings. Under these terms, two are the key elements of shareholder activism: a) the exercise of influence; this phrase indicates the continuous efforts of individuals – usually shareholders – towards the achievement of specific goals; the form of initiatives taken in the context of this activity is not standardized; however, the methods highlighted by Hendrikse et al. (2004), see also above, could be possibly used in the context of shareholder activism, b) the exercise of influence – as described above – need to be related to the interests of shareholders; this means that shareholder activism is not likely to be developed in order to support the interests of other organizational stakeholders, for instance the employees or the suppliers. In the study of Morris et al. (2009) it is noted that traditionally, the shareholders exercise their influence on the management through their voting right; however, the shareholder activism has resulted to the increase of the power of shareholders to influence the decisions of the top management in regard to key organizational issues. In accordance with Morris et al. (2009) the period during which shareholder activism was more developed was from 2003 up to 2004; at that period, shareholder activism mostly focused on the following two issues: the directors’ compensation and the implementation of the laws regulating the corporate governance – referring especially to the Combined Code of 2003 (which was further updated in 2006 and 2008) (Morris et al., 2009, p.694) 3. Types of shareholders and their modes of engagement The rights and the power of shareholders within organizations are not standardized; rather, they are differentiated in accordance with the percentage of the participation of each shareholder in the equity of the organization; in this context, shareholders can be categorized as follows: a) institutional shareholders, b) major shareholders, c) small shareholders and d) the holders of employee shares (Siems, 2008, p.65); the power of the shareholders of each of the above categories to exercise their influence on the top management, i.e. to develop shareholder activism initiatives is not equal; however, the benefits of such activities – referring to shareholder activism activities - usually involve in all shareholders even if these activities are initiated by institutional shareholders. Among the shareholders of the above categories, the institutional shareholders are considered as having the major power of control within their organization; in fact, this is a phenomenon highly developed in Anglo-American countries; the above issue is explained in the study of Aras et al (2010) who note that ‘in UK institutional shareholders hold substantial minority stakes in most firms’ (Aras et al., 2010, p.288); in USA also, it has been revealed that ‘more than 20% of the 1000 most powerful corporations established across the country is controlled by families/ owners’ (Aras et al., 2010, p.288). The issue of differentiation in the types of shareholders within organizations is also discussed in the study of Griffin (2006); in accordance with the above study, two are the major categories of shareholders in modern organizations: the ordinary shareholders and the preference shareholders; the former can be further categorized in accordance with the provisions of a firm’s constitution – where the terms of the provision of ordinary shares of different forms can be defined – for instance ‘ordinary shares with no voting right or those with enhanced voting right’ (Griffin, 2006, p.141). As for the preference shares, their major differentiation from the ordinary shares is that they refer to the potential right of their holder to ask for dividend before the dividend to the ordinary shareholders is paid (Griffin, 2006, p.141). 4. Evidence on shareholder activism In accordance with the empirical research developed in USA, shareholder activism has a positive effect on the organizational performance; the main empirical studies, on which the above assumption is based, are ‘those of Black (1998), Gillan and Starks (1998), Karpoff (2001) and Romano (2001)’ (Polinsky et al., 2007, 896); a different view is expressed by Hoskisson et al. (2008); in accordance with the above researchers, shareholder activism cannot have a crucial influence on the organizational performance; the case of the California Public Employees’ Retirement System is mentioned by Hoskisson et al. (2008) as an example justifying the specific view. More specifically, it is explained that the above Fund ‘acts aggressively to promote decisions and actions that enhance shareholder value’ (Hoskisson et al., 2008, p.311); however, it is noted that the actual benefits of the above Funds activity are not those expected by the Fund’s managers. On the other hand, Stowell (2010) refers to the case of RiskMetrics Group as the example of a company that has strongly ‘attacked shareholders’ rights plans’ (Stowell, 2010, p.243); the specific practice of RiskMetrics Group has been followed by other USA firms which found the specific strategy as an effective tool of protection ‘from takeover attempts’ (Stowell, 2010, p.243). In accordance with Solomon (2007, p.137) one of the most significant questions in regard to the performance of shareholder activism is whether these initiatives of shareholders affect positively or not the performance of companies involved; the above question is related to the widely accepted view that shareholder activism is related to the shareholders’ wealth (Solomon et al., 2007, p.137). An important characteristic of shareholder activism is that it can be differentiated among shareholders in different countries. Such example is provided in the study of Black and Coffee (1998) where British investors are compared with US investors. It is noted that ‘the U.K. has the same array of institutional investors as the U.S and an equally powerful securities market’ (Black and Coffee, 1998, p. 1997); in practice British investors are more active than US investors. However, when having to suggest the change of management in their companies, British investors may avoid stating their view under the fear that they may cause damage to their firm’s performance (Black and Coffee, 1998, p. 1997). On the other hand, the form of shareholder activism can be differentiated across firms – in accordance with the targets set and the means used. An indicative example is provided through the study of Kahan and Rock (2007); the above researchers refer to the case of corporate control activism which can be developed in three different modes: a) through hedge funds which are used in order to block acquirers, b) through hedge funds that are used in order to improve the terms of the acquisition for the shareholders of the target firm and c) hedge funds are used as a tool for acquiring a company (Kahan and Rock, 2007, p.1034). 5. Conclusion The improvement of governance in companies has been proved to be related with a series of factors: the level at which shareholders are allowed to support their interests within their organization is likely to be differentiated across industries and markets; markets that are characterized by strong competition are more likely to develop strong shareholder activism compared to markets which are characterized by the dominance of specific organizations – this is particularly the case in certain developing countries which are dominated by organizations of the public sector, i.e. in those countries where the intervention of the state in business activities is extensive, for instance in China and in certain emirates. In the case of UK, the adoption of the Stewardship Code by the British firms would help towards the increase of protection of shareholders’ rights; however, it would be necessary, that ‘consultation is provided in order for the Code to operate effectively’ (HM Treasury, 2009). 6. Recommendations The development of shareholder activism within modern corporations could support the rights of shareholders either in the short or the long term; however, the effectiveness of the specific practice is not guaranteed – as proved through the empirical evidence presented above. For this reason, it is necessary that alternative plans of action are available. The adoption of the Stewardship Code would be an important part of this effort but its effectiveness would be depended on the preparation made but also on the market conditions. Additional measures would be taken aiming to achieve the following targets: a) improve the communication across the organization, b) increase the firm’s competitiveness in its industry, c) avoid high costs in the development of the relevant tasks, d) check the performance of similar practices in other corporations operating in the same sector and e) inform the corporate stakeholders on the initiatives developed – aiming to control the development of resistance towards the changes attempted. References/ Bibliography Aras, G., Growther, D. (2010) A Handbook of Corporate Governance and Social Responsibility. Gower Publishing, Ltd. Black, B and Coffee, J (1998) Hail Brittania: Institutional investor behaviour under limited regulation, Michigan Law Review, 92, pp.1997-2087 Campbell, D., Craig, T. (2005) Organisations and the business environment. Butterworth-Heinemann, 2005 Davis, P., Steil, B. (2004) Institutional Investors. MIT Press Dignam, A., Galanis, M. (2009) The globalization of corporate governance. Ashgate Publishing, Ltd. Gillan, S and Starks, L. (1998) Survey of shareholder activism: motivation and empirical evidence, Contemporary Finance Digest, (Autumn, 1998) 2, 3 10-34 Griffin, S. (2006) Company law: fundamental principles. Pearson Education Hendrikse, J., Hendrikse, L. (2004) Business governance handbook: principles and practice, Volume 1. Juta and Company Ltd HM Treasury, Great Britain (2009) Pre-budget report December 2009: securing the recovery, growth and opportunity. The Stationery Office Hoskisson, R., Hitt, M., Ireland, R. (2008) Competing for Advantage. Cengage Learning Kahan, M and Rock, E.B (2007), Hedge funds in corporate governance and corporate control, University of Pennsylvania Law Review, 155, 5 Morris, G., McKay, S., Oates, A. (2009) Finance Directors Handbook. Butterworth-Heinemann Mutingwende, R. (2008) Hedge Funds: The Protean Survivalists: Of Shareholder Activism and Other Investment Strategies. GRIN Verlag Polinsky, M., Shavell, S. (2007) Handbook of law and economics, Volume 2 Handbooks in economics. Elsevier Schneeman, A. (2009) Law of Corporations and Other Business Organizations. Cengage Learning Siems, M. (2008) Convergence in shareholder law. Cambridge University Press Solomon, J. (2007) Corporate governance and accountability. John Wiley and Sons Stowell, D. (2010) An Introduction to Investment Banks, Hedge Funds, and Private Equity: The New Paradigm. Academic Press Sturm, S. (2009) The Influence of Institutional Investors on Corporate Management and Corporate Governance in Germany: A Multi Perspective Analysis. GRIN Verlag Visser, W., Matten, D., Pohl, M., Tolhurst, N. (2010) The A to Z of Corporate Social Responsibility. John Wiley and Sons Read More