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
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 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
 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
Anglo-American Rhenish governance
Russia globally
India China Brazil
model Capitalism
Ownership Dispersed Concentrated, Concentrated in Highly Highly Highly
structure interlocking either the hands concentrated; concentrated in concentrated
pattern of of owner-mangers recent tendency to state-owned ownership by
ownership between or the wider more dispersed companies; fairly family owned
banks, insurance circle of ownership concentrated in business groups;
companies, and employees in private wave of
corporations joint-stock enterprises privatization
corporations since 1990 has
Ownership Individuals Banks Owner-managers Families State Familystate
reduced owned
identity Pension and Corporations Employees Foreign Families business
ownership groups
mutual funds State State investors Corporations State
Banks
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 Sales, market Profit for Long term Long term Long term
ownership value share, headcount owners ownership ownership ownership
Short term Long term Long term Growth of Sales, market Profit for
profits ownership ownership market shares share owners

Board Executives Shareholders Owner-managers Owners Owners Owners/

controlled Shareholders Employees Other insiders Other insiders Party/the state shareholders
by Shareholder Owners Owners Owners Owners Owners
Key
stakeholders Employees State Customers in Guanxi-network Customers in
(trade unions, overseas markets of suppliers, overseas markets
works 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’
 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
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
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 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 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
• 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

Positi Company Industry

on
1. Petrobras (Brazil) Oil and gas
2. Samsung Electronics (South Consumer electronics
Korea)
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)
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
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