Shareholders and Business Ethics

Lecture 6
(Ch.6)

(Revised on 18th Feb. 2019)

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 Contents
1. Understanding corporate governance (Shareholders as
stakeholders)

2. Ethical issue in corporate governance

3. Shareholders and globalization

4. Shareholding for sustainability

5. Shareholders as citizenships of corporation

6. A glance on some alternative designs of ownership

structures (in relation to sustainability)

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 1. Understanding corporate governance
(Shareholders as stakeholders)
1. What is Corporate governance (“referred to as ‘CG’)?*
• Corporate governance describes the process by which shareholders seek to
ensure that ‘their’ corporation is running according to their intentions.
• It includes processes of goal definition, supervision, control, and sanctioning.
• Narrow sense:-
• It includes shareholders and the management of a corporation as the
main actors;
• Broader sense:-
• It includes all actors who contribute to the achievement of stakeholder
goals inside and outside the corporation
• CG is not about the usual term “management” in a company
• “CG” is duty of directors/ board of directors (to ensure the company is
being well run and that it is running in the right strategic direction)
• “Management” is the duty of the managers/ executives.
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*Pp.204-205, Crane & Matten (2016); & Unit 3, BUS B368F, Distance Learning Materials (2016), The Open University
of Hong Kong
 1. Understanding corporate governance
(Shareholders as stakeholders)

*Pp.16-17, Unit 3, BUS B368F, Distance Learning Materials (2016), The Open University of Hong Kong 4
 1. Understanding corporate governance
(Shareholders as stakeholders)
2. Shareholders (as stakeholders)*
• Crucial problem stemmed from “separation of ownership and
control”
• Locus of control
(e.g. The Board has the control, but not the shareholders)
• Fragmented ownership
(e.g. Company shares are held by so many different
shareholders)
• Divided functions and interests
(e.g. Interests of shareholders are not necessarily the interests of
the Board members; it can cause conflict of interest)

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*P.205, Crane & Matten (2016)
 1. Understanding corporate governance
(Shareholders as stakeholders)
2. Rights and duties in shareholder relations*
Rights of shareholders
• To sell their stock
• To vote in the general meetings
• To access certain information about the company
• To sue the managers for alleged misconduct
• Residual rights (in company’s liquidation)
(e.g. to share remained assets after repayment of all debts in liquidation)
Duties of managers
• Duty to act for the benefit of the company
(e.g. short-term profitability vs. long term survival and developments)
• Duty of care and skill
(e.g. Duty to work in professional way to run the company)
• Duty of diligence
(e.g. Expected level of active engagement in company’s affairs) 6
 1. Understanding corporate governance
(Shareholders as stakeholders)
2. CG: Principal & Agent relationship
Relationship:
• Shareholders:  Principal / Company
• The Manager/Board:  Agent (to act for the best interest of the
principal/ company, namely “fiduciary duty”)
Agency problem:
(1) Inherent conflict of interest (Company’s interest vs. Individual interest)
(2) Informational asymmetry (Insiders have more sensitive information)

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*Pp.207-208, Crane & Matten (2016)
 2. Ethical issue in corporate governance
1. Executive accountability and control
• A separate body of people that supervises and controls management
on behalf of shareholders.
• Dual structures of leadership:
• Executive directors are actually responsible for running the
corporation
• Non-executive directors who hold no full-time positions. They are
supposed to ensure that corporation is being run in the interests of the
shareholders
• Structure of the board of directors:
• Anglo-Saxon model (Single-tier board)
• European model (Two-tier boards)
• Lower tier board is represented by executive directors,
• Upper tier (also known as “supervisory board”) are represented
major stakeholders (i.e. employees, banks and trade unions). 8
*P.213, Crane & Matten (2016)
 2. Ethical issue in corporate governance
Examples (Governance Scandals - Agency Problems)
Olympus (2013)
• The newly appointed CEO Michael Woodford discovered the
company had hidden $1.5 billion of investment losses. The scandal
wiped out 75% of company’s valuation in the stock market.
UK Co-operative Bank (2013)
• A cornerstone of the co-operative movement was virtually stopped
when the bank was privatized by a consortium of American hedge
funds which would dramatically change the firm’s ethical objectives
and co-operative ethics.
General Motors (2014)
• GM concealed faulty ignition switch problem and recalled a total of
2.5 million cars. The company was sued by shareholders.

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 2. Ethical issue in corporate governance
1. Executive accountability and control
• Independent Non-executive Directors (INEDS)
• The central ethical issue is the independence of the supervisory, non-
executive board members.
• Criteria for ensuring NO direct conflict of interests:
• Typically appointed INEDS from outside the corporation (not a related
party of the existing board members);
• INEDS have no personal financial interest in the corporation;
• They are appointed for limited time;
• They are competent to judge the business of the company;
• They have sufficient resources to get information;
• They are appointed independently (by shareholders in AGM).

*Pp.213-214, Crane & Matten (2016)

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 2. Ethical issue in corporate governance
2. Executive remuneration
(a) ‘Fat cat’ salary accusations
• E.g. Top ten average CEO earning in the USA were about $100
million each.
• Average annual pay rise for CEOs 11% CEO increases outstrip
shareholder returns
• The ratio of salary of CEO and worker in US increased to 350 : 1
(b) Ethical problems with executive pay:
• Performance-related pay leads to large salaries that can cause
instabilities in corporations
• Influence of globalization on executive pay leads to significant
increases of ethical problems
• The board often fails to reflect shareholder (or other stakeholder)
interests
*Pp.214-215, Crane & Matten (2016) 11
 2. Ethical issue in corporate governance
3. Mergers and Acquisitions
• M&A is acceptable if the result is that the transfer of assets to owner
who can use the resources more productively.
• The central concern is the managers who pursue their self-interests
which are not consistent with shareholder interests.
• Executive power & prestige vs. profit and share price
• Hostile takeovers
• It causes concern when shareholders do not want to sell their
shares.
• Intentions and consequences of mergers and acquisitions
• Restructuring and downsizing, ‘asset stripper’, employees/
communities were disregarded.
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*P.216, Crane & Matten (2016)
 2. Ethical issue in corporate governance
4. Financial markets & insider trading
(a) Speculative ‘faith stocks’
• ‘Dot-com’ bubble (companies have not made profit but the
companies can worth billions in value in the market)
• Ethical issue: Focusing on faith/ speculation; ignoring
uncertainties in the business
(b) Insider trading (Note: not only unethical, but illegal)
• It occurs when shares are bought and sold on the basis of
internal materials and non-public information (Moore 1990)
• Ethical arguments
• Fairness (inequality of information; use of secret/ sensitive
information)
• Misappropriation of property (information is property of the firm)
• Harm to investors and the market (as it is unfair)
• Undermining of fiduciary relationship (breach of trust) 13
*P.217, Crane & Matten (2016)
 2. Ethical issue in corporate governance
5. Reforming corporate governance
• Main reforms in Codes of Corporate Governance prescribed ‘best
practice’, standards for corporations, 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

*P.217, Crane & Matten (2016)

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 2. Ethical issue in corporate governance
5. Reforming corporate governance
• Legal basis and power of these codes of governance varies
significantly between countries.
Principles based approach (e.g. having choices to comply the rules or not)
• emphasis on complying or explaining
• E.g. If you don’t comply with the rules, you need to explain the reason(s))
• the company states that it is compliant or alternative why this is not the
case.
• This approach is also used in listing rules of many stock exchange in the
world, where it is a matter of judgement, as various disclosure should be
made, but often companies follow the ‘best practice’.
Mandatory/ Compulsory approach (e.g. must comply under laws)
• USA’s response to Enron’s Scandal :
• Sarbanes-Oxley Act (2002) - fail to comply is a criminal act.
• USA’s response to 2008 financial crisis:
• Dodd-Frank Act (2010)
• The Volcker Rule Legislation (2014) 15
*P.217, Crane & Matten (2016)
 3. Shareholders and globalization
1. 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:
1) Governance and control
• No national government is entitled to govern them.
• No control over many of mortgage-based securities being traded globally
and many international banks came under pressure.
2) Speculation
• E.g.: Currency hedging and other capital movements
3) National security and protectionism
• E.g.: sovereign wealth funds (i.e. funds owned by government)
4) Unfair competition with developing countries
• 60% of the Chicago wheat exchange are speculative, price can fluctuate
• Drastic effect from sudden withdrawal of capital (e.g. 1998 financial crisis)
5) Space for illegal transactions
• E.g.: Terrorism, money laundering, drug trafficking, tax evasion and illegal
trade of weapons etc. 16
*Pp.223-225, Crane & Matten (2016)
4. Shareholders as citizens of the corporation
1. Shareholder democracy
• A shareholder of a company is entitled to have a “say” in
corporate decisions
• “A community of people that have an important stake in company
and therefore able to influence it in some way”*
(e.g. just like people have democracy in a country.)
• Three issues to consider:
1) Scope of activities
(e.g. some shareholders may be interested in profit-maximization only,
some others may be interested in substaintability.)
2) Adequate information
(e.g. shareholders are not involved in daily operation, if they need to
evaluate an issue, they may not have specific information)
3) Mechanism for change
(e.g. shareholder activism, & socially responsible investment)
*Pp.230 - 231, Crane & Matten (2016) 17
4. Shareholders as citizens of the corporation
2. Shareholder activism
• Buy shares in company for the right to speak at the Annual General
Meeting (AMG)
(e.g. Greenpeace has purchased some shares of SHELL)

• Voiced out concern and challenged the company on allegedly unethical

practices
• Possibility of having broad media attention by ‘disrupting’ the meeting
(E.g. the leverage of effect can be high)
• Issues:
• Gets involved with ‘the enemy’
• Only an option for reasonably wealthy individuals
• An approach to change the behavior of a company by engaging
stakeholder(s) to communicate with the management (e.g. to address or
draw attention to ethical, social or environmental issues etc.).
*Pp.231 - 232, Crane & Matten (2016)
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4. Shareholders as citizens of the corporation
3. Socially responsible investment (SRI) / Ethical investment
• To invest in companies which provides financial returns and also achievement of
social, ethical, and environmental goals.
• Relevant considerations in investment decision (examples):
• The ‘Sustainability Framework and the ‘Equator Principles’:
• Guidelines for commercial banks, as provided by International Finance
Corporation (the private sector of World Bank); it became a set of United
Nation ‘Principals for Responsible Investment’ (launched in 2005; has
been accepted by over 1,300 investment entities).
• Dow Jones Sustainability Indices
• Good corporate governance on ESC criteria (Environment, Social, &
Governance”)
• Climate change; deforestation; & relations with indigenous people
• UN Principles of responsible investments; e.g.:
• incorporate ESG issues into investment decisions;
• incorporate ESG issue into ownership practices;
• seek disclosure on ESG issues; promote principles with the investment
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industry; enhance effectiveness in implementation; & report progress
*Pp.232 - 233, Crane & Matten (2016)
4. Shareholders as citizens of the corporation
3. Socially responsible investment (SRI) / Ethical investment
• SRI Funds - Top 10 stocks SRI funds 2012 (p.234, Crane & Matten (2016))

Position Company Industry

1 Samsung Electronics (South Korea) Electronic
2 Taiwan Semiconductor (Taiwan) Electronic
3 China Mobile (China) Telecommunications
4 Industrial & Commercial Bank of China Financial Services
5 American Movil (Mexico) Telecommunications
6 Petrobras (Brazil) Oil and gas
7 Gazprom (Russia Oil and gas
8 CNOOC (China) Oil and gas
9 China Construction Bank (China) Financial services
10 Vale (Brazil) Mining

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5. Shareholders for sustainability
1. Using sustainability indices
• Some organizations (specialized in index calculation) have been
creating share indices to rate/evaluate corporate’s performance on
sustainability since the late 90’s.
• Dow Jones Sustainability Indices (DJSI) (Note: A well-known index in market)
• FTSE4Good Global index (Note: Financial Times & Stock Exchange)
• DJSI uses ‘best-in-class’ approach
• To identify sustainability leaders in each industry
• Companies are put into index based on some criteria:
• Environmental factors
E.g. environmental system design, management commitment)
• Economic sustainability
E.g. sound management & CG system, anti-corruption policies, & supply-
chain management etc.
• Social sustainability
E.g. employment policies, stakeholder dialogue & human rights policies21
etc.
*Pp.237 - 238, Crane & Matten (2016)
5. Shareholders for sustainability
1. Using sustainability indices
• Criticisms of index:
• Quality of data
• Index is calculated largely based on the data provided by the
corporation itself.
• Questionable criteria
• E.g. some oil companies and cigarette companies are
included in the index and it causes controversy.
• Assessment method
• Focuses on management processes rather than on the actual
sustainability of the company or its products

*P.238, Crane & Matten (2016)

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5. A glance on some alternative designs of ownership
structures (in relation to sustainability)
1. State-owned firms (SOE)
• Some enterprises/corporates (providing telecommunication, public
utilities, health care etc.) are owned by the government (e.g. in France,
& China)
• E.g. Government still has controlling stakes in Volkswagen.
2. Family-owned firms
• Company owned by family, normally focus on long-term goals (e.g.
reputation) rather than short term profit maximization.
3. Co-operatives (hybrid form of ownership model)
• The company is not set up for profit, but for meeting the needs of
members (E.g. retail shop in remote part of Sweden; & agricultural co-
operatives to share tools in developing countries.)
• Neither owned by investors nor by their managers, but owned and
democratically controlled by their workers or their customers
*P.240, Crane & Matten (2016) 23
5. A glance on some alternative designs of ownership
structures (in relation to sustainability)
4. Social purpose corporations (SPC)/ Social Enterprises (SE)
• SPC is “A type of corporation that is legally required to pursue a social
purpose in addition to its commercial goals”* (Emphasis added)
• legislations in some European countries create a whole new category for
incorporation*:
• Pursue a general public benefit in addition to profit
• Consider the effects of their decisions on shareholders, employees,
suppliers, customers, community, and the environment;
• Produce annual benefit report detailing public benefits.
• In HKSAR, it is also known as Social Enterprises.

(Continue)

*Pp.244 * 245, Crane & Matten (2016)

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5. A glance on some alternative designs of ownership
structures (in relation to sustainability)
4. Social purpose corporations (SPC)/ Social Enterprises (SE)
• As described by the Home Affairs Bureau (HAB), HKSAR, on supporting
general or sector-wide promotion activities for SE:
“There is no universal definition of social enterprise (SE). In
general, an SE is a business to achieve specific social objectives such
as providing the services (such as support service for the elderly) or
products needed by the community, creating employment and training
opportunities for the socially disadvantaged, protecting the
environment, funding its other social services through the profits
earned, etc. Its profits will be principally reinvested in the business
for the social objectives that it pursues. In other words, the primary
objective of an SE is to achieve its social objectives, rather than
maximizing profits for distribution to its shareholders.* (Emphasis
added)

*As cited in Official Website of Social Enterprise (https://www.social-enterprises.gov.hk/en/introduction/whatis.html)

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accessed on 23rd Sept. 2018)
5. A glance on some alternative designs of ownership
structures (in relation to sustainability)
4. Social Enterprises (SE)
• Example:
Diamondcab
“Diamond Cab (HK) Ltd. is a private enterprise offering point-to-point
transportation services for wheelchair users. We have 7 barrier-free cabs that
allow wheelchair users to board directly and provides a legal and safe
transportation means for wheelchair users and their carers. Up to mid-April
2016, we have successfully completed over 100,000 barrier-free trips.”

Important notice:
This photo extracted from website is
strictly used for academic purpose
only. No copying is allowed.

[1] “About us” of the website of Diamondcab (https://www.diamondcab.com.hk/en/about.php) accessed on 23rd Sept.
2018) 26