Lecture Corporate governance and ethics: Chapter 10 - Rezaee

Chapter 10 - Stakeholders’ roles and responsibilities. Chapter 10 discuss shareholder responsibilities in monitoring the effectiveness and validity of corporate governance, provide insight for strengthening shareholder rights, discuss the role institutional investors play in ensuring effective and responsible corporate governance, provide methods employees can use to participate in the monitoring of corporate governance and examine activities by investor activists to strengthen corporate governance reforms.

Stakeholders’ Roles and Responsibilities

Chapter X

Chapter Objectives:

• Discuss shareholder responsibilities in monitoring the effectiveness and validity of corporate governance.

• Provide insight for strengthening shareholder rights.

• Discuss the role institutional investors play in ensuring effective and responsible corporate governance.

• Provide methods employees can use to participate in the monitoring of corporate governance.

• Examine activities by investor activists to strengthen corporate governance reforms.

Key Terms

Blockholding

Employee class actions

Free-rider problem

Institutional shareholder

Intercorporate networks

Property rights

Security class actions

Shareholder democracy

Shareholders and other stakeholders, including employees, customers, creditors, suppliers, and society, by being attentive and engaged, play an important role in corporate governance

Recent corporate governance reforms have raised investor expectations for corporate governance, and any attempt to relax or roll back these reforms would be disappointing to investors and adversely affect their confidence in public financial reports and the capital markets

The two biggest corporate bankruptcies in U.S history, Enron and WorldCom, and the failures of other high-profile companies primarily caused by fraud, which cost investors and pensioners more than $500 billion, made investors take notice and demand corporate accountability

Shareholder monitoring

The effectiveness of the monitoring and control function by investors is determined based on the interrelation factors of:

(1) property rights established by law or contractual agreement that define the relations between a company’s investors and its management,

as well as the existence of such relations between different types of investors;

(2) financial systems facilitating the supply of finances between households, financial intermediaries, and corporations;

(3) networks of intercorporate competition and cooperation establishing relations between corporations in the marketplace

Shareholders Proxy Process

In July 2007, the SEC approved two proposals addressing the shareholder proxy process

I. The first proposed rule would require public companies to allow shareholder access to the company’s proxy statements (Proxy access proposals are shareholder proposals that enable shareholders to nominate director candidates who would be named in the company’s proxy statement)

II. The second proposed rule would facilitate electron shareholder forums This proposal permits companies and others to develop their own format, content, and methods of electronic shareholder forums

Security Class Actions

The Private Securities Litigation Reform Act (PSRLA) of 1995 was passed to bring more focus to private lawsuits

Private lawsuits are vital mechanisms for enforcing securities laws, compensating defrauded investors, and improving corporate governance

to be used effectively by institutional investors, particularly public pension funds

Institutional Investors

investment trusts, mutual funds, and investment management groups often hold substantial outstanding shares of public companies Institutional investments in the United States have grown significantly in the past five decades and will continue to grow as more employees participate in pension funds

Institutional Investors

Monitoring

screening system based on financial performance (e.g., benchmarks), identifying problem areas and concerns, and determining causes and effects of the problems

by (1) exercising their right to elect directors, (2) raising their concerns about the company’s governance by either selling their shares or voicing their dissatisfaction, (3) improving the efficiency of the capital markets by transmitting private information they obtain from management to the financial markets, and (4) reducing agency problems by possessing resources and expertise to monitor the managerial and oversight functions

as well as reduce information asymmetry between management and investors

Governance of Institutional

Investors

fiduciary duty of managing these funds for the best interest of their individual investors (principals)

 AND

for monitoring public companies’ governance

beneficiaries or trustees, they should disclose their corporate governance and voting policies as well as potential conflicts of interest and how they manage them

Mutual Funds

The SEC has taken several mutual fund initiatives designed to: (1) address late trading, market timing, and revenue sharing that create conflicts of interest between management of mutual funds and their shareholders;

(2) improve transparency of disclosures to fund investors; (3) strengthen the oversight function of mutual funds by improving their governance, ethical standards, compliance, and internal controls

The CCO is accountable to the fund’s board

Mutual funds and their advisors should comply with the requirements of code of ethics (according to SEC requirements adopted in July 2004)

Hedge Funds

Hedge funds and other private equity investors play an important role in influencing corporate governance issues by promoting investor protection

as their primary goal

The hedge fund industry accounts for trillions of investment

assets The SEC rule requires that hedge fund advisors managing more than $25 million for more than fifteen clients register with the SEC

The SEC has recently aggressively enforced the insider trading laws for insider trading abuses by both individual investors and market professionals (e.g., a UBS research executive, a Morgan Stanley attorney)

Employee Monitoring

In modern corporations, particularly in the era of technological advances, labor resources are becoming an important part of corporate governance

as capital resources

Employee participation in corporate governance can influence managerial control and authority, and can influence employee cooperation in the implementation of decisions

The most popular form of participation is Employee Ownership (ESOPs)

Combining labor capital and equity capital by ultimately moving to employee owned corporations can substantially reduce agency costs by empowering employees and protecting both labor and equity capital

Employee Role in Corporate

Governance

This goal of company value maximization can be achieved when employees own the company’s shares

The employees’ total compensation should be divided into

(1) Performance of the assigned job,

(2) performance of firm-specific skills

corporate misconducts, fraudulent financial activities, or violations of applicable laws, rules, and regulations without the fear of retaliation

An effective whistleblower program should improve corporate

governance

Conclusion  

• The monitoring function of corporate governance is the direct responsibility of shareholders and other stakeholders, and can be achieved through direct participation of investors in business and financial affairs of corporations.

• Shareholders play an important role in monitoring public companies to ensure the effectiveness of their corporate governance and strengthen shareholder rights by (1) providing timely access to information, (2) enhancing shareholders’ rights, and (3) promoting shareholder democracy.

• Institutional investors can play an important role in reducing information asymmetry between management and shareholders by obtaining private information from management and conveying that to shareholders and, thus, the capital markets.

• Employee participation in corporate governance can influence managerial control and authority,

and can influence employee participation in decision making and cooperation in the implementation of decisions.

• Institutional investors influence the governance of public companies in which they invested by putting forth proposals intended to improve corporate governance effectiveness.