Firms Behaving Nicely: Incentives and Commitment by Michael Klein

Ever since the rise of large firms in the 18th century, debate has been raging about how to combine economic efficiency and productivity with socially desirable behavior of firms. This paper reviews the debate starting with the classic corporate governance argument about shareholder rights. It discusses the potential incentives to exploit other stakeholders unduly and examines some mechanisms, beyond contracts and regulation, to cope with this exploitation.

In this light it considers reputational mechanisms, using the example of corporate social responsibility, and changes to the constitution of firms, with emphasis on the nonprofit form of enterprise. Based on evidence so far, the for-profit firm with mechanisms assuring sound shareholder rights remains preferable to the alternatives. However, scope for experimentation with mechanisms such as different classes of shareholders with differing voting rights may be socially useful, which suggests that global corporate governance principles thus should not be prescriptive in detail.  Download the publication here.

About the Author:

Michael Klein is a professor of development policy at the Frankfurt School of Finance and Management in Germany and a senior adjunct professor at the School of Advanced International Studies of Johns Hopkins University.

Foreword by Colin Mayer.

Power to the shareholder

by Brendan Sheehan for Business Insider, June 14th, 2011.

Although technological advancements may allow companies to hold virtual annual meetings, both investors and executives can benefit from convening in person.

In recent years, the trend has been towards sharply declining public attendance at corporate annual meetings. Some companies have even toyed with the idea of canceling the in-person meeting altogether and instead hosting “virtual” meetings via the Internet. Indeed, some of these online forums are highly acclaimed and well attended. Once the bastion of shareholder activism and the main opportunity for investors to interact with the board, have annual meetings become irrelevant in an age of instant information delivery? Most Fortune 500 companies get fewer than a couple hundred people through the doors.

In a stunning reflection of its CEO’s famed contrarian investment style, Berkshire Hathaway defies this trend. As you will read in Directorship’s June/July cover story, Berkshire’s recent annual meeting attracted some 40,000 people, who gathered to listen, learn, question and be entertained by Berkshire’s Charles Munger and Warren Buffett. The fact that so many people attend the event is as much an indication of how the company views its shareholders, as it is the way investors and the public view Berkshire and its iconic leader. (continue reading… )

Suddenly, Poison Pills Are Relevant Again

by Frank Aquila for Bloomberg Business Week, February 23rd, 2011.

A Delaware judge’s decision upholding Airgas’s shareholder rights plan comes just as hostile takeover bids are heating up. Columnist Frank Aquila reviews the corporate defense practice

Shareholder rights plans, so-called poison pills, have long drawn the ire of the institutional investor community and have lost favor with Corporate America. But a Delaware judge’s recent decision to uphold Airgas’s poison pill—followed by Air Products & Chemicals’s prompt termination of its hostile bid—confirms that rights plans are still the most potent takeover defense available to targets of unsolicited bids.

The unsolicited offer by Air Products (APD) for Airgas (ARG) has been one of the longest-running hostile bids in recent memory. Seeking to bring its offer for Airgas to a resolution, Air Products asked the Delaware Chancery Court to invalidate Airgas’s poison pill. Although the case centered on the facts in that corporate saga, the Feb. 15 decision by Judge William B. Chandler III to affirm Airgas’s shareholder rights plan has broader implications at a time when unsolicited bids are again becoming a common tool for strategic buyers.

Unsolicited offers have picked up since the subprime mortgage crisis. To be sure, today’s unsolicited bids are not triggering the hostile takeover fights of days gone by, which unalterably changed Corporate America. The nomenclature that developed around the bids of the 1970s and ’80s justifiably evoked the imagery of pirates and raiders. The terminology remains the same, but the nature, tactics, and objectives of strategic buyers have little in common with those employed by the greenmailers and corporate bust-up artists of that era. (continue reading… )

 

EU Still Not Taking Shareholder Rights Seriously

by Scott Hirst for The Harvard Law School Forum, November 14th, 2010.

Proponents of the global shareholder activism movement have recently praised the EU for generously empowering shareholders through the so-called Shareholder Rights Directive (“SRD”) (Directive 2007/36/EC). A year after the deadline for the transposition of the SRD into national corporate laws an article in the current issue of European Company Law entitled Is the EU Taking Shareholder Rights Seriously? An Essay on the Impotence of Shareholdership in Corporate Europe checks what progress has really been made regarding the issue of shareholder involvement in European corporate governance.

The article attempts to show that the deficit in the European corporate governance model with regard to the status of the shareholders persists even in the post-SRD era and that there is still a long distance to be covered in order to truly empower shareholders in the EU. The deficiencies of the past in shareholder governance have not been cured by the SRD, while the latter does not interact satisfactorily with the existing EU and national legal framework in order to unfetter shareholders from the mechanisms that restricted their active engagement.  European corporate law is still captive of an ideology that wants other corporate constituencies to be protagonists in corporate affairs.

First of all, the sterilization of the shareholder voting right in Europe is examined. The SRD is accused of introducing a dysfunctional “pull” system of dissemination of pre-meeting information that does not tackle the well-documented problem of shareholder passivity. In turn, the problem of tight record and “cut-off” dates is examined. It is concluded that sufficient time is not allowed for the voting entitlements and the voting instructions to travel up the chain of financial intermediaries that stand between the end investor and the corporation and as a result many shareholders are effectively disenfranchised. (continue reading… )

Shareholder rights and corporate governance: Be the vanguard of your destiny

by Eze Nwagbaraji for Vanguard, September 12th, 2010.

In an altruistic world, markets should function in near efficient pathways. Market regulators would be vigilant and protect the interests of those who have been invited to participate in the build up to robust markets.

The primary focus of the market regulator would be to use sound economic and market principles to advance the interests of all participants and those who lose money in the markets, will at its minimum be confident that they lost money in a fair market, where success and failure are based purely on their abilities and knowledge to understand the principles of risks and reward.

Altruism is not a term that is associated with the rough and tumble world of investing. This is the primary reason for the creation of market umpires, known as regulators, whose primary function is to supervise all market activities, protect those who come to participate in the market, deter those who come to markets to game the system and its participants, and punish those caught in sharp practices and market manipulation.

The lead umpire in securities and equity markets is the Securities and Exchange Commission, set up as a government structure to referee the workings of the market. The Nigerian Securities and Exchange Commission (SEC) represent our decisive attempt to put in place the proper structure to lead the workings of our markets and assist in the advancement of a coordinated functional securities and equities system that assures the investing world that ours is a market worth trusting.  (continue reading… )

Do Inefficient Stock Markets Drive Bad Corporate Governance?

By Sergey Chernenko, Fritz Foley, and Robin Greenwood, for Forbes.com, June 2, 2010

Why do minority shareholders continue to hold stock despite the risk of expropriation by controlling shareholders? In this column, Sergey Chernenko, Assistant Professor at the Fisher College of Business at the Ohio State University, Fritz Foley, Associate Professor in the Finance area, Harvard Business School, and Robin Greenwood, Associate Professor at the Harvard Business School, provide two decades of evidence from Japan suggesting that many investors do not foresee these conflicts of interest, even when there is plenty of disclosure. Inefficient stock markets allow majority shareholders–often parent companies–to sell overpriced stock only to buy it back at a later date.

One of the major accomplishments of recent corporate governance research has been to expose the risks confronted by minority shareholders in public companies around the globe. Corporate ownership structures such as pyramids, business groups, and dual class shares leave control in the hands of a limited set of blockholders – exposing minority investors to potential expropriation.

Why, then, do minority shareholders participate in these arrangements? The prevailing academic view since Jensen and Meckling (1976) is that capital markets are efficient in the sense that minority investors foresee the possibility of expropriation by controlling shareholders. As a result, under this view, the share price that minority investors are willing to pay reflects their rational expectations of expropriation and other agency problems. And because outside equity is expensive, controlling shareholders will only raise equity capital from minority investors if there are commensurate benefits, such as attractive growth opportunities that the firm would not be able to finance otherwise.

A new view on why agency problems arise

In recent research (Chernenko et al. 2010), we propose a new and alternative view for the emergence of ownership structures that are prone to severe agency problems. Motivated by the growing literature studying the effects of stock market mispricing on firm behaviour (see for example Stein 1996, Shleifer and Vishny 2003, and Baker 2009), we develop a simple framework for thinking about how stock market mispricing can offset agency costs and induce controlling shareholders to raise outside equity….(continue reading)

Corporate Governance Challenges

by Boardmember, January 2010.

Today, corporate directors are facing some of the most difficult challenges experienced by U.S. companies in decades. The severity of the economic recession, the repercussions of the government financial bailout, and the resulting highly charged political landscape have all converged to make this a demanding time to serve as a public company director.

The economy
Directors surveyed for the 2009 What Directors Think research shared the actions their companies have been taking in response to the economic challenges at hand. Cutting expenses was the most prevalent response: 72% say they are reducing staff levels and 62% say they are cutting or deferring capital expenditures (Figure 1). On a more positive front, only about a third of directors report postponing planned expansion or divesting or closing business units. Roughly half the directors say they are using the economic situation as an opportunity to look for good acquisitions. Overall, 60% of directors think boards need to devote more time to discussing the impact of the economic situation compared to the past (Figure 2).

Another optimistic finding shows that despite the turmoil in the markets and economy, more than half the directors surveyed do not feel these events have placed a strain on the relationship between the board and management (Figure 3). This is a positive finding, given the need for boards and managements to overcome obstacles and to work in tandem to develop successful strategies for future growth and stabilization. A primary challenge for boards will be increased regulatory oversight, which nine out of 10 directors agree will occur as a result of the economic downturn (Figure 4)…(continue reading)

TXI Announces Corporate Governance Changes

by CNN Money, January 13, 2010.

DALLAS, Jan. 13, 2010 (Globe Newswire) — The Board of Directors of Texas Industries, Inc. (NYSE:TXI) has voted unanimously to take action to effect the following changes in its corporate governance policies:

* Terminate the current Shareholder’s Rights Plan as of November 1, 2012.

* Begin “Declassifying” the Board of Directors with the class of Directors elected at the 2010 Annual Meeting of Shareholders.

* Elect directors in the future based upon Majority rather than Plurality standards.

The Board of Directors believes these proactive governance changes reflect the desires of the majority of its shareholders…(continue reading)

MindTree Adjudged Best Indian Company in Asia in Corporate Governance

by Asiamoney, for India PR Wire, January 6, 2010.

MindTree Ltd., a global IT Solutions Company, announced today that it has been ranked 2nd in Asia in the Corporate Governance Poll 2009 conducted by Asiamoney magazine. MindTree is ranked No. 1 Best Overall For Corporate Governance in India. In addition to being picked up as the second best company overall in Asia, MindTree is ranked No. 1 in the continent (excluding Japan) in the two categories of ‘Responsibilities of Management and the Board of Directors’ and ‘Shareholders’ Rights and Equitable Treatment’. MindTree is ranked among the top three in the categories of ‘Disclosure and Transparency’ and ‘Investor Relations’.

In India, MindTree is ranked No. 1 in all the categories, thereby winning the overall No. 1 rank in Corporate Governance. MindTree’s Chief Financial Officer Rostow Ravanan has been chosen as ‘The Best Investor Relations Officer in India’.

Asiamoney’s Corporate Governance Poll surveyed 104 senior executives and research analysts from 96 firms, and cited more than 250 companies across the region to discover where Asian companies rank in several categories involving corporate clarity. The publication stated, “The results of this survey are especially notable, given that the polling period coincided with some of the most pronounced financial market volatility in history.”…(continue reading)

Survey Finds Slight Improvement in Corporate Governance Among Hong Kong-Listed Companies

by ACN Newswire, November 26, 2009.

A survey on the corporate governance standards of companies listed in Hong Kong conducted by The Hong Kong Institute of Directors (“HKIoD”) and Hong Kong Baptist University (“HKBU”) found a slight improvement in the quality of corporate governance practices of Hong Kong companies last year.

“The HKIoD Corporate Governance Score-card 2009” survey is organised by HKIoD and executed by HKBU’s research team led by Professor Stephen Cheung, Chair Professor of Finance and Dean of  School of Business, and sponsored by the Corporate Governance Development Foundation Fund. The first report was published in 2004 and the latest set of findings is the third, which have shown improvement over the years.

Compared with the second Score-card published in 2006, the 146 companies studied on average achieved a 1.44% improvement in their Corporate Governance Index (“CGI”) score. As for the five areas “rights of shareholders”, “equitable treatment of shareholders”, “role of stakeholders”, “disclosure and transparency” and “board responsibilities” the first three improved notably whereas the last two had slightly lower CGI scores. The decline might have stemmed from the expanded number of rating criteria mostly used in the last two areas in this survey…(continue reading)