In this chapter we look at the possible divorce between ownership of businesses and those who make most of the day to day decisions on how that business operates in one or more markets.

Ownership and control

The owners of a private sector company normally elect a board of directors to control the business’s resources for them. However, when the owner of a company sells shares, or takes out a loan or bond to raise finance, they may sacrifice some of their control.  Other shareholders can exercise their voting rights, and providers of loans often have some control (security) over the assets of the business. This may lead to conflict between them as these different stakeholders may have different objectives. The flow chart below attempts to show the possible divorce between ownership and control.

The Principal Agent Problem

How do the owners of a large business know that the managers they have employed and who are making the key day-to-day decisions operate with the aim of maximising shareholder value in both the short term and the long run?

This lack of information is known as the principal-agent problem. In other words, one person, the principal, employs an agent (e.g. a sales or finance manager) to perform tasks on his behalf but he or she cannot ensure that the agent always performs them in precisely the way the principal would like. The decisions and the performance of the agent are both impossible and expensive to monitor and the incentives of the agent may differ from those of the principal. The principal agent problem is illustrated in the flow chart above.

Examples of the principal-agent problem that have hit the headlines recently in the UK include the mis-management of financial assets on behalf of investors (e.g. the case surrounding Equitable Life) and the management of companies on behalf of shareholders (e.g. during the turbulent years experienced by Marks and Spencer and Shell). The classic case in the United States is of course the Enron fraud and debacle. Follow this BBC news link for more background on the Enron case.

Incentives Matter! - Employee Share Ownership Schemes

There are various strategies available for coping with the principle- agent problem. One is the rapid expansion of employee share-ownership schemes and share-options programmes.  The government has encouraged the wider use of share-ownership schemes through a series of tax incentives. But the use and occasional misuse of share options schemes has been controversial for several years. A recent example involved the US computer giant Apple.

The growth of "shareholder activism"

Many commentators are now questioning the assumption that shareholders play little direct role in influencing corporate strategy in modern corporations. There are plenty of examples in recent times when both institutional and individual shareholders have exercised their voting rights to express views on the direction that a company is taking or its performance. Typically they are critical of a perceived failure of a business to maximise shareholder value measured in terms of share price, the flow of dividend incomes etc.

An activist shareholder uses an equity stake in a business to put public pressure on its management. The rapid expansion of hedge funds who take equity stakes in many businesses has cemented the idea of shareholder activism. Many hedge funds take minority equity stakes and then try to get the existing management to divest poorly performing or unprofitable parts of a business and focus instead on core activities.

That said it remains the case that the general pattern of ownership and control within British industry is relatively dispersed. Typically the largest shareholder in any large business listed on the stock market is likely to own a voting minority of the shares. Majority ownership by a single shareholder is unusual. The usual presumption from this is that only the very largest shareholders have any incentive to participate in corporate decision making and few shareholders have any real voting power.

Examples of recent shareholder activism
Sainsbury's: In 2004, a third of J Sainsbury's shareholders voted against the supermarket's pay policy, objecting to its decision to give a £2.3m bonus to ousted chairman Sir Peter Davis. Sainsbury's subsequently decided to cancel the controversial pay award. Sir Peter Davis quit Sainsbury's after a group of major institutional shareholders demanded management changes. He was replaced by Justin King.
Disney: In 2004, Michael Eisner, the chairman and chief executive of Disney, resigned after 43% of Disney shareholders voted against his re-election.
Euro Tunnel: In 2004, the management board of EuroTunnel was ousted at the company's AGM. Private French shareholders were encouraged to protest by share tipster Nicolas Miguet and French campaign group, ADACTE because of the huge loss of share value and the assertion that the company could be turned around by a new board. EuroTunnel has continued to experience heavy losses and in July 2006 it filed for bankruptcy protection.
Vodafone: In May of 2006, Vodafone announced the biggest loss in British corporate history (£14.9 billion). Vodafone reported one-off costs of £23.5 billion due to the revaluation of their Mannesmann subsidiary. In July 2006, the CEO of Vodafone Arun Sarin came under huge pressure from a group of shareholders unhappy about the performance of the struggling telecoms company.

Corporate Social Responsibility and Business Ethics

Business ethics is concerned with the social responsibility of management towards the firm’s major stakeholders, the environment and society in general. There is a growing belief that ethical and ‘green’ business are linked to improved business performance over time because of increased public concern for human rights and the world environment. Many businesses are now trumpeting their progress in making their activities carbon neutral for example by offsetting the impact of their production activities on their environment through offset activities. Businesses such as Carbon Clear provide a means by which organisations can find ways to offset their carbon emissions.

Business ethics extends to treating all stakeholders ‘fairly’; hence the growing emphasis on health and safety issues, good working practices and the like in business decision-making.

For more reading on this try this link to the Institute for Business Ethics. The Times 100 Case Studies includes one on Cadbury’s and corporate social responsibility.  Click here for BBC news articles on carbon neutrality.