AGM -an ineffective forum for shareholder democracy - Essay Example

AGM - An ineffective forum for shareholder democracy Corporate governance - an awkward phrase with several definitions among which the simplest andeffective is the one that describes corporate governance as a system by which companies are directed and controlled (Committee on the Financial Aspects of Corporate Governance, 1992)1. The first thing is that this definition talks about systems (not minutiae or individual items) and specifically addresses direction (the board) and control (shareholders) rather than management. This is the division that has created the corporate governance industry and should not be taken to mean that any less importance attaches to good management than it did, or that there is a great divide between corporate governance and management in practice. Corporate Governance supports businesses that are well managed, well directed, and well controlled. Indeed one of the functions of good corporate governance is to help ensure that good management is in place. Nevertheless, some of the most conspicuous failures in recent years have stemmed from a failure of the control function or from poor direction. Corporate Governance in context with International aspects All systems of corporate governance have to be considered against the social, economic, legal, and political background of the country in which they developed. A study of the relevant laws governing corporations does not reveal enough in any country unless they are understood on the basis of attitudes and patterns of behaviour to make sense of them. Examples are that of the company laws of Japan and the UK that are not too dissimilar in structure, but the results are poles apart. When we examine remuneration we find a marked difference in approach between the USA and Germany, where exorbitant share schemes have in the one become common and barely exist in the other. According to Charkham & Simpson (1999) "The impact upon competitiveness appears irrelevant, however other differences tell us that banks play a much larger part in Germany and Japan, not because of any deliberate policy, but because their economies happened to develop in ways in which this occurred and by the same token the stock market has a bigger role in the UK and USA"2 (Charkham & Simpson, 1999, p. 28). Reforms on both sides show that no system is immune to pressure for change, be it domestic or international. One purpose of good corporate governance is to reduce this accident rate, because unnecessary collapse is so damaging to all concerned; and where it occurs in a major company may be catastrophic. Another purpose is to encourage management to seize opportunities, and we can only speculate on how many have not been taken in the UK over the years. Corporate governance as a subject therefore is as broad as life itself, because it touches upon fundamental elements in the economy and society at large. The Role of AGM The reason for considering AGM ineffective might be the choice of a year as the period between company meetings appear a reflection of the world of nature and the tyranny of the seasons, rather than any particular logic dictated by the needs of any organisation that is not subject to them. Shareholders recognised this in the political world by having elections at various intervals and, even the UK has itself varied and to this day does not have a uniform period between elections for all levels of government. This means AGM does not support shareholders in terms of democratic elections and as far as companies are concerned, there is no particular reason, especially in these days of overflowing information, why the annual AGM cycle should be a year long. Sometimes it might be a half-year, or a quarter, for that matter eighteen months or two years, there is no particular timings for conducting regular elections. On the other hand taxation has a bearing on the choice of period and most governments raise taxes on an annual cycle but even this is not necessarily immutable and the accounting period does not have to be twelve months either; indeed companies do from time to time have a different period when they are changing their financial year end from one date to another. There is no point of questioning the seeming inevitability of a specific and familiar pattern namely one year is that it does not necessarily coincide with the most sensible intervals for assessing the performance of an enterprise either internally or from outside. In commercial organisations AGM allows simultaneously various cycles to which an organisation needs to review its aims and objectives from time to time the apotheosis of introspection. It does not serve to do this too often, to become over-introspective is to risk doubt and uncertainty and to live without it is to risk becoming aimless. The process of monitoring is however continual, irrespective of the intervals between rendering account. AGM allows the processes of management to be reviewed so that decision-taking should be made, both short and long term depending on the issues. This leads to two conclusions: 1) The periodic general meetings are and always have been about stewardship in any kind of organisation. In those with an economic purpose like a company, accounts are an indispensable way of quantifying the competence of the stewardship, though they are not its only measure. Most employees and shareholders want to feel proud of their companies or at the very least sympathetic to them. Accountability increasingly extends beyond it, very obviously in environmental matters, and as 'stakeholder' thinking develops, it will get broader. 2) The cycle of business operations, which by no means fits into regular cycles of precisely one year, is made to adapt to it by accounting alchemy accruals and deferrals, depreciation, and all that. What the accountants can do for a business is what photographers with an ordinary camera can do at a football match. Even so, business is a movie and accounts are snapshots. The Role of Accounts Accounts acts as the chief exhibit at annual general meetings and the main evidence of stewardship to which they put numbers to the chairmen's narratives, their excuses but not, because of the conventions, to their hopes unless a bid has been launched. In order to analyse the company's performance, the loophole in AGM is that one prefers to have a look at the numbers rather than the words, because they appear to facilitate comparisons with past performance, with other firms in the sector, and with the market as a whole. AGM pressurizes the judgement to be replaced with formulae, so as to be able to replace the skilled by the semi-skilled. On many shareholders attitude, this rests in part on the fallacy that numbers are more precise and accurate than words and as anyone who has compiled a set of accounts knows, almost every number is a judgement. This leads them to the confusion for which they are unable to make out what the stock is really worth, which debtors will fail, which dire contingencies will reduce the value of a project This way the values in the balance sheet are virtually meaningless, as the periodic collapse of property prices demonstrates. These reasons have caused the shareholders to think in various dimensions regarding the conventions that affect issues of corporate governance including accounting and valuation that may tend to curb optimism and induce prudence, but they cannot ensure accuracy. Thus viewed from the inside, the AGM is nothing but a nuisance that always interrupts the normal flow of business for the executive members of the board and a great many of their supporting staff. The Annual General Meeting is used to having to squeeze the normal rhythm of business into the ill-fitting corset of annual accounts, but the job will have been done even not without disagreement on some points with the auditors. AGM has unnecessarily been the factor responsible primarily for the relatively insignificant role of pension funds in direct institutional monitoring, this also largely explains the relative prominence of the insurers in that area: in general it is fund managers that meet (regularly) with, talk (regularly) to, and engage (occasionally) with the management of companies. Stapledon (1996) recognizes the significance of insurance in Corporate Governance while suggesting that a large proportion of the life and general funds of UK insurance companies is managed by investment-management subsidiaries of the various insurers, therefore according to Stapledon (1996) "if it is reported in the press that the Prudential, Norwich Union, and Scottish Amicable have applied pressure for management changes at company X, it is actually Prudential Portfolio Managers Ltd., Norwich Union Investment Management Ltd., and Scottish Amicable Investment Managers Ltd. the respective fund-management subsidiaries that would have been involved"3 (Stapledon, 1996, p. 34). In contrast, the reason why pension funds have not often been involved in direct monitoring lies in the fact that most of them have for many years employed external fund-management firms to undertake the investment of their funds. Shareholders common complains One of the pillars of company law is the principle of majority rule both at the level of the board of directors and the company in general meeting, company decisions are generally decided by a simple majority vote. But while the concept of majority rule is fundamental, it carries with it the potential for abuse of power. At the outset, it is necessary to draw certain distinctions, both as to the nature of minority shareholders' complaints and as to the nature of the company in which they occur. Indeed, these two factors are interrelated, since the nature of the company will determine whether and to what extent minority shareholders are affected by particular forms of conduct. At one end of the spectrum of company types is the listed public company where risk bearing and management are separated, and most shareholder complaints therefore relate to dissatisfaction with management. They may stem from disagreements over policy matters, charges of inefficiency or negligence, or, more seriously, that the controllers are profiting at the expense of the company. The one advantage that minority shareholders in listed companies have when faced with these situations is that in many cases they will be able to avoid the problem by selling their shares. Nevertheless, there are some situations where disposal of their shares will not be a satisfactory option. For example, the conduct of the controllers may have depressed the value of the shares, the minority may not wish to dispose of their stake for personal or strategic reasons, or a sale may not be viable because the shares were purchased as part of an indexed fund. These companies are generally formed on the basis that decisions will be reached by consensus rather than a strict application of majority rule and it is usually as a consequence of a breakdown in the personal relationship between the participants that one party takes advantage of a controlling position to oppress the other. Thus, although complaints may relate, for example, to bad management or self-interested conduct, such conduct has a much more personal effect on the minority than in a listed company. Further, there is a greater potential for the oppressive conduct to take other forms. A reversion to strict majority rule consequent upon a breakdown of relations may result in the frustration of the minority shareholder's expectations as to his or her rights and obligations. Foremost among these is usually an expectation of participation in management. Exclusion from this role may have particularly serious consequences. First, an isolated minority shareholder in a small private company may well have little or no say in the running of the business of the company. Secondly, at least it has been rare for private companies to pay dividends. Instead, most of the profits have been applied towards directors' remuneration, with any surplus going to reserves. The excluded shareholder may therefore suddenly be placed in the position of receiving no return on his or her investment. To the extent that institutions are active as shareholders, this generally also benefits other shareholders. However, in some cases it operates to their disadvantage where the most significant disadvantage to other shareholders is in terms of access to information. The preferential position of the institutions means that different channels of communication have developed between them and the companies in which they invest. "Not only do other shareholders not have access to these channels, but their existence weakens the statutorily enshrined methods of communication, namely the general meeting and the annual report and accounts"4 (Boros, 1995, p. 15). An alternative source of voting advice in Britain is Pensions Investments Research Consultants ('PIRC') which was founded in 1986 by a consortium of local authorities as an ethical issues research organisation for pension funds. It offers a proxy voting service covering the top 250 companies ahead of their annual meetings, analysis of corporate governance issues, and specific advice to clients on how to vote at shareholders meetings. Furthermore Boros (1995) states that "PIRC's advice not only reflects the principles of the Cadbury Code, but also monitors environmental reporting, political donations, directors' remuneration and the 'insulation' of directors, whereby executive directors are not required to retire regularly for re-election by shareholders" (Boros, 1995, p. 37). Shareholders opposing proposals Institutional shareholders have consistently opposed proposals with the potential to reduce their stake or influence within a company and which consequently make it easier for management to insulate itself against a takeover. Such proposals may, for example, take the form of an issue of shares which is not first offered to existing shareholders on a pro rata basis issues of non-voting shares or conversely of super-voting shares. Following are the examples: Pre-emption Rights Disapplication of pre-emption rights became a controversial issue in the United Kingdom in 1986 and 1987 when companies tried to raise money overseas. In response to concern about dilution of shareholders' interests, the investment committees of the Association of British Insurers (ABI) and the National Association of Pension Funds (NAPF) reissued guidelines on the circumstances in which their members would consent to a disapplication of their statutory pre-emption rights. In an effort to resolve the conflicting interests of the parties involved, the London Stock Exchange convened a pre-emption group which included representatives of institutional investors and companies. "The group recommended guidelines which were subsequently agreed by both the ABI and the NAPF, and which influenced Stock Exchange Listing Rules" 5 (Stapledon, 1996, p. 40). Shares with Differential voting rights The issue of non-voting equity shares arouses strong reactions in institutional shareholders because of its potential to entrench management and so operate as a takeover defence. This issue split the Jenkins Committee, the majority taking the view that a legislative ban on nonvoting shares would be too drastic a step. Although opposing a ban on issuing shares with differential voting rights, the committee recommended that non-voting or restricted voting shares be clearly labelled as such. Nevertheless, opposition by institutions to the creation of equity shares which do not carry full voting rights has been maintained, and it would appear that on a practical level this opposition has been largely successful. "In June 1993, there were only 50 United Kingdom companies (with a total market capitalisation of 13,535.2 million) which had differential voting rights, and Weinberg observes that 'there are no instances in recent years of a company seeking a listing for any new class of non-voting equity capital" (LSE, 1993). "Conversely, there are recent examples of non-voting shares being enfranchised" 6(Davidson, May 1993). Other Mechanisms of Corporate Governance Now is the time for the shareholders to divert their attention towards corporate Mechanism like issues involving share exchange through price signals, the role that board functions are playing in management and accountability, non-executive directors, institutional investors, auditors and auditing in corporate governance issues. Indeed, corporate governance mechanisms consist of economic and legal institutions, such as the design of bankruptcy procedures, the allocation of control to the board of directors, policies for the retention of retiring chief executive officers (CEOs) and other executives, the design of managerial compensation contracts, and so on. Also relevant are economic and legal institutions concerning controlling rights and property rights and to explore how these economic and legal institutions particularly bankruptcy laws, managerial compensation contracts, and policies for retaining retiring executives (on the board of directors) can regulate the management of non-financial firms. Shareholders can analyse the allocation of control rights among various stakeholders in the event of default, and how to design managerial compensation arrangements to deal with the corporate governance problem. The effects of significant increases in the securitisation of corporate financing and the amount of financial innovation, which have recently been observed in many developed countries, can be observed in-depth. According to Osano & Toshiaki (2001) "These two financial phenomena bring a large number of various securities to the financial market: asset backed securities (ABS), collateralised mortgage obligations (CMO), mortgage backed securities (MBS), floating rate bonds, zero coupons, swaps, options, indexed securities, money market funds, and so on" 7(Osano & Toshiaki, 2001, p. 3). There are new securities to be concerned about, as well as traditional securities, such as equities, preferred stocks, bonds, convertible bonds, warrants, and commercial papers, are issued to satisfy different kinds of motives. In the presence of informational asymmetries between firms and suppliers of capital, firms face an adverse selection problem in that firms with highly productive investment opportunities may be imitated by firms with lower productive investment opportunities. In this situation, the ingenious design of securities can promote the dissemination of information about risky projects in which firm managers issue securities to signal the firm's potential value and opportunities, or their efforts and abilities. The ingenious design of securities can also resolve the corporate governance problem by enhancing the role of the large investor (rather than small investors) as a delegated monitor who disciplines the performance of a company's management. Furthermore, the creation of new securities can provide investors with an opportunity to trade previously unavailable contingent claims. Hence, the problem of security design affects the behaviour not only of issuing firms but also of investors and financial intermediaries, including venture capitalists. Corporate monitoring comprises acts directed at all companies or at a certain category of company, rather than at any particular company ('industry-wide monitoring'). Industry-wide monitoring consists generally of the devising and promulgating of some kind of recommended practice. It extends to the lobbying of government, the Stock Exchange, and other regulatory bodies for the introduction of new laws and/or regulations and the reform of existing ones. "Firm-level monitoring takes a much wider range of forms, including the exercise by institutions of the voting rights attached to their equity holdings; periodic meetings between institutions and company managements; the appraisal of company managements by shareholder-elected non-executive directors; and the attempted replacement of an under-performing management team by a coalition of institutional shareholders"8 (Stapledon, 1996, p. 79). Governance mechanisms and the role of dividend policy that includes the interactions between different mechanisms are not necessarily same and should be analysed according to the country's specific regulatory context. As regards corporate financial policy, there is not yet a complete theory nor strong empirical evidence showing how agency costs determine an optimal debt-equity ratio and dividend policy for the firm. In regard to incentive share schemes, one problem is that there is UK empirical evidence showing little or no link between the remuneration of executive directors of quoted companies and the performance of those companies. A second problem is that, whilst reducing (theoretically, at least) the incentive for managers to shirk, an executive share scheme actually compounds a different problem. There is an asymmetry between the attitudes to risk of managers and diversified shareholders (like institutions). The use of shares and share options as incentive remuneration serves to further decrease the diversification of the manager's income stream. Compulsory disclosure and audit also suffer from defects. In regard to the audit, concerns have been expressed about whether in practice auditors 'work with' management rather than 'working for' the shareholder body. There are also problems with non-executive directors as monitors of management performance. Finally, for reasons given already, neither the body of legal duties owed by directors and senior executives, nor the governments' regulatory regimes affecting companies, plays a significant role in motivating executive management to maximise shareholder return. References Boros J. Elizabeth, (1995) Minority Shareholders' Remedies: Oxford University: Oxford. Charkham Jonathon & Simpson Anne, (1999) Fair Shares: The Future of Shareholder Power and Responsibility: Oxford University Press: Oxford. Committee on the Financial Aspects of Corporate Governance (Cadbury Committee) (1992), Report, London: Gee Publishing, Dec. Davidson, H. "Regent Street truce begins to crack" In: Sunday Times, 16 May 1993, Business Section. London Stock Exchange, "Non-voting and restricted voting shares in UK companies" In: Stock Exchange Quarterly, April-June 1993. Osano Hiroshi & Toshiaki Tachibanaki, (2001) Banking, Capital Markets and Corporate Governance: Palgrave: London, New York. Stapledon G. P., (1996) Institutional Shareholders and Corporate Governance: Clarendon Press: Oxford. Read More