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 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 governance globally
Anglo-American Rhenish Russia India China Brazil
model Capitalism
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’
 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

Position Company Industry

1. Petrobras (Brazil) Oil and gas

2. Samsung Electronics (South Korea) Consumer electronics
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
(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