Who owns the corporation?

Prof. dr. R. A. M. Pruijm RA

• Emeritus professor Erasmus University

• Lector Corporate Governance Fontys

• Director Knowledge Centre Finance & Accounting

Content• Why is it so important?• The corporation and its stakeholders• Who is in charge?• Shareholder’s democracy?• Activist shareholders• Conclusion

Why is that important?

Who owns the corporation?

Who owns Microsoft?• Market-

capitalization: $265 billion

• Employees: 80.000

Who owns ABN Amro?• Market

capitalization: 71 billion euro

• Employees: 107.000

• Who is the owner?– Fortis?– Banco Santander?– Royal Bank of

Scotland?

Why is it important?• Corporations are essential for the

world economy• How a company operates is

important• The purpose of a corporation is

important• Who is in charge is important

Largest Public CompaniesSales Profit Assets Market

ValueExxonMobil 335 40 224 410

General Electric

163 20 697 358

Microsoft 46 12 66 275

Citigroup 146 22 1884 247

What is a corporation?• Corporation derives from the Latin Corpus a

“body of people”• A legal entity which has a separate legal

personality from its members (shareholders)• To undertake tasks too risky or too expensive for

individuals to embark upon• Oldest corporation: Stora Kopparberg mining in

Falun, Sweden in 1347• Other examples: Dutch East India Company and

Hudson’s Bay company

Stora Kopparberg share

Dutch East India Company share

Legal characteristics• Own legal personality

– An juristic person• Transferable shares

– Shareholders can change without affecting its status• Perpetual succession capacity

– Continued existence despite shareholders death or withdrawal

• Limited liability– For corporate debt, from judgments against the

corporation, amnesty from criminal actions of the corporation

Advantages• For the corporation

– Easy (equity) capital– Low costs (no dividend obligation, no interest)

• For shareholders– Limited risk (as many shares as you want,

from different corporations)– Chance of a profitable investment (increase in

price of shares, and possible dividend)– Easy exit by selling shares

Corporation• Publicly traded

corporation, the shares of which are traded on a public market, e.g. The New York Stock Exchange

Ownership and Control• Persons can have the right to

vote or share in the profit of corporations

• These voters hold shares of stock and are called shareholders

Ownership and control• Control of the corporation is

determined by a board of directors, elected by the shareholders

• The board consists of executive and non-executive members

• Executive officers are chosen by the board to manage the daily affairs of the corporation

Limited liabiliy• Sharholders are said to have a "residual

interest.“• Should the corporation end its existence, the

shareholders are the last to receive its assets, following creditors and others with interests in the corporation.

• This can make investment in a corporation risky; however, a diverse investment portfolio minimizes this risk.

• Shareholders also receive the benefit of limited liability regulations, making shareholders liable for only the amount they contributed.

Agency problem“Corporate governance deals with the

ways in which suppliers of finance to corporations assure themselves of getting a return on their investment … the agency problem” Shleifer & Vishny ‘A survey of Shleifer & Vishny ‘A survey of corporate governance’, corporate governance’, TheThe Journal Journal of Finance of Finance (1997)(1997)

Agency problem• Separation of Ownership and

control Berle & Means, Berle & Means, The Modern The Modern Corporation and Private Property Corporation and Private Property (1932)(1932)

Shareholders Shareholders (Principals)(Principals)

Firm OwnersFirm Owners

Agency RelationshipAgency Relationship

Risk Bearing SpecialistRisk Bearing Specialist(Principal)(Principal)

Managers Managers (Agents)(Agents)

DecisionDecisionMakersMakers

which createswhich creates

Managerial Decision-Managerial Decision-Making SpecialistMaking Specialist

(Agent)(Agent)

HireHire

The Agency ProblemThe Agency Problem

Corporate Governance “The directors of such companies, however, being

the managers rather of other people's money than of their own, it cannot well be expected, that they should watch over it with the same anxious vigilance with which the partners in a private copartnery frequently watch over their own .... Negligence and profusion, therefore, must always prevail, more or less in the management of the affairs of such a company?”

Adam Smith, An Inquiry into the Nature and Causes of The Wealth of Nations (1776)

Corporate Governance “Corporate governance deals with mechanisms by which

stakeholders of a corporation exercise control over corporate insiders and management such that their interests are protected. The stakeholders of a corporation include equity-holders, creditors and other claimants who supply capital, as well as other stakeholders such as employees, consumers, suppliers, and the government.”

John & Senbet (1998) ‘Corporate governance and board effectiveness’, Journal of Banking & Finance

Employees

Suppliers

Corporation

Consumers

LendersCommunity

Shareholders

Corporate StakeholdersCorporate Stakeholders

Shareholderpower =

Large takeovers• VNU• Euronext en New

York Stock Exchange• Rodamco Europe en

Unibail• ABN Amro• Stork• But also

– ICI door AKZO Nobel

Governance debate• Who is in charge

–Directors or shareholders?–Primacy debate

• What is the purpose of the corporation?–Shareholder wealth maximization–Stakeholder wealth maximization

Competing Models

Who’s in Charge?

Towards What End?

Stakeholder theory

Managers and Directors

Stakeholders

Shareholder primacy

Shareholders and Directors

Shareholder wealth

maximization

Primacy debate: shareholders

• Shareholders are the owners of the company

• The residual claims argument• Agency cost argument

Are shareholders the owners?

• Most common argument: Milton Friedman in 1970–The shareholders of the corporation

are “the owners of the business’, the only social responsibility of business is to increase its profits.

Misunderstanding

Owners?• Legal entity without

owners• Shareholders own

stock, not the corporation

• As owners of stock their rights are limited

• Ownership argument is empirically incorrect, nobody owns the corporation

Residual Claimants?• Shareholders do have an implicit

contract that–Entitles them to whatever remains

after the firm has met its obligations and paid its fixed claims

–According to this claim, firms should be run toward maximizing shareholder wealth

Correct?• Only in bankruptcy• No further entitlement,

only when– Directors are able to

decide that they should receive a dividend

– The firm is doing well enough

Agency costs• Directors are only human

– They have fiduciary duties to the constituents of the firm

– But they also have their own interests and may shirk or even steal from the firm.

– Agency costs can be reduced when one can monitor and measure an agent’s performance.

Result• Stockprice is the

only measure that reflects how well directors are doing their job

Empirical evidence?

Lawmakers• Law generally follows

the stakeholder model• Corporate directors

must serve shareholders and other stakeholders

• Business world prefers the stakeholder model

• Shareholder value is an important metric

Stakeholder theory• Seeks to achieve a balance of risks and

rewards• Fiduciary duties of directors will act in

accordance of all the corporate constituencies, primarily for the shareholders

• Stakeholder theory is not to challenge the supremacy of the shareholder. It is that the shareholder will be ultimately better off if they allow directors to pursue long-term objectives

Mitigating the Agency Problem

• Internal control mechanisms– Independent directors appointed by

shareholders– Audited financial statements – Performance–based compensation

• External control mechanisms– Managerial labour market– Market for corporate control– Shareholder activism

Shareholder (critical) rights

• Put items on the agenda of the meeting of shareholders for discussion

• Appointment of non-executive board members

• Approval of major decisions

• Right of dismissal of all non-executive board members

• Approval annual report

Activist shareholders• Barbarians at the

gate• Locusts• Corporate raiders• Only short term

profit counts• Our companies are

being robbed

Examples?

Who are shareholders?

Profile• Most of them are foreign investors:

75%• Most of them are institutional: 70%

– Banks– Insurance companies– Pensionfunds– Hedge funds

Example• 87% institutional

investors• 13% private

investors

Large investorsHolding Voting rights

ING 10% 2%

UBS 3% 5%

Fortis 7% 1%

Kempen Capital Mgt. 6% 0,3%

Eureko 5% 1%

Aviva 8% 1%

Aegon 6% 0,3%

Stichting Prerente Aandelen 41% 2%

The loyal shareholder?

Institutional:Holding period 15 months

Private investors:Holding period 7 months

ABN Amro shareholders:Holding period 13 months

In Perspective1960 7 years

1992 2 years

2006 7 months

Long-term investment?

No.Shareholders are short-term

investors

What is a shareholder?• Short-term

investor• Focus on short-

term profit• Consider

companies as a commodity

Implications• Principle of

“Shareholder democracy” completely gone

• Employees pay the bill

It is all about profit

Shareholder democracy?• Tourists don’t

vote!• Gamblers don’t

own the casino!

Active voting?

Only 40% of the shareholders are present at the annual shareholders meeting of the largest Dutch companies

Trend• Hedge funds like the activist shareholder

approach– cheap with a good chance off rich profits– They will not restrict themselves to relatively small

investments– Example: Stork (more than 40% controlled by hdge

funds)• Sovereign wealth funds

– They become large shareholders, driven by (strategic political) interests (3000 billion dollar)

– Example: Barclays, Citigroup, Merrill Lynch

Result• New playing field

–Limited number of investors with large holdings, and no longer many investors with small holdings

–They will dominate in the decision making process without any obligation to buy the company

A shift in power

More companies wentbankrupt throughmismangement than byactivist shareholders

Ruud Pruijm

But

Conclusion• Nobody owns the corporation• Balance between stakeholders is in

danger by increasing shareholder’s dominance

• Short-term approach will be prevalent, there are no long-term shareholders anymore

• In the end, the employees will pay the bill

CVProf. Dr. R. A. M. Pruijm CPA is management-consultant, interim-manager and professor emeritus Accounting Information Systems at the Erasmus University Rotterdam. He was recently appointed as part-time lecturer Corporate Governance at the Fontys Professional University. He is a well-known expert in corporate governance, corporate social responsibility, and business ethics.

Corporate governance is a generic term that describes the ways in which rights and responsibilities are shared between the various corporate participants, especially the management and the shareholders. Corporate governance is about promoting corporate fairness, transparency and accountability.Corporate social responsibility is about open and transparent business practices, that are based upon ethical values and respect for employees, communities, and the environment, designed to deliver sustainable value to society at large and to shareholders.

For over 30 years Professor Pruijm has been speaking to top level business executives and organizations all over the world. He is author of numerous books and articles, and is a regular guest on radio and television. As an independent observer and thought-leader he is frequently consulted by the press, politicians, and business leaders.

Office: Kievit 12 -1135111 HD Baarle NassauTel. 013 – 507 03 41Mobile 06 547 36 391E-mail: ram.pruijm@ext.eur.nl