Crane and Matten

Business Ethics
ETHICS AND CORPORATE
GOVERNANCE
Shareholders and Business Ethics

STAKEHOLDERS?
 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 (Internal vs External)
• The extent to which and individual believes they have control over the events in their
life. Believe events are shaped by their own efforts or external forces.
• Locus means the palce where something is situated or site or location or centre of
activity.
• The actual control of owners assets are ion thge hands of directors.
• Shareholders have at best indirect and impesonal control over their property.

– Fragmented ownership
• Several unrelated parties can share in and mitigate the risk. i.e. Percenbtage of
onwnership. No one person can consiodred the owner in the same way as as sole
proprietor.
 Crucial problem: separation of
ownership and control
– Divided functions and interests
• The interstes and benefits of managers and sharehloders may not be the same.
Shareholders want more dividends and managers want job security.
 Rights and duties in firm-
shareholder relations
• Rights of shareholders
– The right to sell their stock/shares
– 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.
Other actors may include directors, internal and external
auditors, regulators, and block holders like fund managers.
 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-managers 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

 Pension and  Corporations  Employees  Foreign investors  Families business groups
identity  State  State  Banks  Corporations  State
mutual funds

Changes in Frequent Rare Frequent, but Traditionally  Rare, but  Rare

decreasing extreme rare, but increasingly  Increasing
ownership
tendency recently changing dynamic influence of foreign
investors

Goals of  Shareholder value  Sales, market  Profit for owners  Long term  Long term  Long term
 Short term profits share, headcount  Long term ownership ownership ownership
ownership  Long term  Growth of market  Sales, market  Profit for owners
ownership
ownership shares share

Board  Executives  Shareholders  Owner-managers  Owners  Owners  Owners/

 Shareholders  Employees  Other insiders  Other insiders  Party/the state shareholders
controlled by
Key  Shareholder  Owners  Owners  Owners  Owners  Owners
 Employees (trade  State  Customers in  Guanxi-network of  Customers in
stakeholders
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. Records show that on CEO outstrip ordinary workers wages
manifolds (highest CEO salaries in 2008: Europe, €77m, USA, $84m)
– 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
– a large payment or other financial compensation guaranteed to a
company executive if they should be dismissed as a result of a
merger or takeover.
• Greenmailing to secure post-merger job
– the practice of buying enough shares in a company to threaten a
takeover, forcing the owners to buy them back at a higher price in
order to retain control.
• Hostile takeovers – concern when shareholders do not want to sell
• Intentions and consequences of mergers and acquisitions
– Restructuring and downsizing
 Ethical aspects of mergers and
acquisitions
• Hostile takeovers – concern when shareholders do not want
to sell.
• A hostile takeover is the acquisition of one company
(called the target company) by another (called the
acquirer) that is accomplished by going directly to the
company's shareholders or fighting to replace
management to get the acquisition approved.
• Intentions and consequences of mergers and acquisitions
– Restructuring and downsizing
 The role of financial markets and
insider trading
• Speculative ‘faith stocks’
• A speculative stock is a stock with a high degree of risk, such as a penny stock or an emerging
market stock. Many traders are drawn to speculative stocks due to their higher volatility relative
to blue-chip stocks, which creates an opportunity to generate greater returns (albeit at a greater
risk). Most long-term investors and institutional investors stay away from speculative stocks
unless they are part of a mutual fund or exchange-traded fund (ETF).

– ‘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 markets and
insider trading
• 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
– There are inequalities in the access to relevant information about companies leading to situation
where one party has an unfair advantage over the other. Moore (1990) argues that this is the
weakest but most common argument that tends to be used against insider.
• Misappropriation of property
– Insider traders use valuable information that is essentially the property of the firm involved and to
which they have no right to access. According to Moore (1990) this has become a common basis for
legal cases involving insider trading.
• Harm to investors and the market
– Insider traders might benefit at the cost of ‘ordinary’ investors. This erodes trust, makes the market
riskier, and threatens confidence in the financial markets.

• Undermining of fiduciary relationship

– The relationships of trust and dependence among shareholders and corporate managers and acting in
the interests of the of shareholders, yet insider trading is fuelled by self-interest. More (1990) argues
that this is the strongest argument against insider trading.
– 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
• Market power of intermediaries.
– Conflict of interest (e.g. cross-selling)
• Pursue their own interest, recommend product they have interest in.
– Long-term relationships with clients
• Matters of familiarity
– Size of the firm
• Difficulty to maintain oversight and controls over standers of diligence as the firms grow in
size.
– Competition between firms (danger of corner-cutting)
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) are traded
worldwide.
• Ethical issues raised:
– Governance and control
• Global markets raise the problem that no national government is entitled to govern
them. There is lack of governance and control over global markets often leading to
negative consequences such as financial crisis.
– National security and protectionism
• If a foreign company want to invest in a company with strategic assets such as
ports. There will be a protectionism.
– Speculation
• Global financial markets encourage speculation. Speculation relates to engaging in
risky financial transaction in the expectation that it will yield substantial benefit.
This is an art of gambling aiming to profit from short term fluctuations.
– 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 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
 Combating global terrorism and
money laundering
• Deregulated social spaces are invitation for illegal financial
activities
• Money laundering estimated at more that $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
Main concerns with SRI movement
– Socially Responsible Investment
• Quality of information
– Most information provided by firms and is difficult to verify
• Dubious criteria
• Too inclusive
• Strong emphasis on returns:
– Firms taking longer-term perspectives and thus sacrificing short-term
profitability therefore unlikely to be included
(See
Vogel, 2005)
Shareholding for sustainability
 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