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Shareholder Value and Investor Engagement

 

According to the International Finance Corporation (IFC) (2006), part of the World Bank Group, the case for shareholder value corporate governance is ‘irresistible’: ‘[a] commitment to good corporate governance—well defined shareholder rights, a solid control environment, high levels of transparency and disclosure, and an empowered board of directors—make a company both more attractive to investors and lenders, and more profitable’. Amongst other data, IFC quoted the McKinsey (2002) Survey of Global Investor Opinion, showing that institutional investors are willing to pay a good governance premium of 30 percent in Eastern Europe and Africa and 22 percent in Asia and Latin America.

In less risky environments, the good governance premium was lower, 8 percent. Firms with good corporate governance secured cheaper debt, and in general outperformed their competitors. The econometric evidence  indicates the possible value of (a reputation for) good corporate governance for market performance. In short, share price market data suggests that there is a premium for good corporate governance, the value of the premium being higher in countries with high political risks.

Shareholder value thus results in higher corporate returns. However, evaluation of the efficiency justifications for shareholder value requires a more fundamental analysis. There are five main justifications for the view that shareholder value is the most efficient form of corporate governance.

The first justification is the perceived inadequacy of internal means of corporate control. Reliance upon internal means of control allows corporate management, and in some circumstances other internal stakeholders, to pursue their own interests, even at the expense of investors. The inadequacy of internal controls leads to the need for external mechanisms to monitor and control corporate management, primarily through the institutions of corporate governance.

The second justification is the efficiency of capital markets as means for resource allocation, a means of transferring resources from areas of low returns on capital investment to areas of higher returns.

The third justification is the role of the capital market in sourcing new capital investment.

The fourth justification is the role of the capital market, especially the venture capital– private equity capital markets, in providing investment capital for high-risk ventures.

The fifth justification is the value of share options as a mechanism for motivating corporate managers.
The first justification for shareholder value and investor engagement is the evident failure of internal means of control. Substantial data support the proposition that the internal control systems of publicly held corporations have generally failed to cause managers to maximize efficiency and value. More persuasive than the formal statistical evidence is the fact that few firms ever restructure themselves or engage in a major strategic redirection without a crisis either in the capital markets, the legal/political or regulatory system, or the product/factor markets.

Corporate executives have strong incentives for ‘entrenchment’ and easily accessible means for realizing the private benefits of control  . Such conclusions are consistent with transaction cost economics theories of the firm, in which ‘a self interest seeking assumption that makes allowance for guile’ is a major behavioural component . The rational self-interest of managers,readilyavailableopportunitiesformanagerialaggrandizement,and the costs of monitoring by investors, as well as inertia, cause internal controls to decay.
However, the assumption that internal controls necessarily fail is unfounded. This blanket judgement neglects variations in the values of corporate management, some of whom are more prone to the unfettered pursuit of self-interest than others. Not all managers act opportunistically in their private interests, although the assumption that they will do so may encourage such an approach. Managerial values vary, for example according to religious beliefs, and organizational cultures, as well as countervailing institutional pressures, such as union organization, may constrain managerial excess. Indeed, stewardship theory, as developed by Donaldson and others, posits a very strong positive conception of management values  . The negative blanket assessment of internal controls also fails to reflect variations in the success of different forms of internal control. For example, the multi-divisional M form of corporate structure, initially developed by DuPont and General Motors in the 1920s, allowed central management to control the corporation through the budgetary process, with considerable success between the 1920s and the 1950s  . Similarly, quasi-market internal structural arrangements and intra-management competition may successfully prevent the exploitation of the corporation by private interests, without the creation of shareholder value institutions. Countervailing power may operate within management, as well as between management and investors. In short, internal controls can work.

The second efficiency justification for shareholder value is its effectiveness as a means of transferring resources from inefficient, or at least unprofitable, sectors to more efficient or profitable sectors. At the macro level, capital markets and the contest for corporate control result in the reallocation of resources from less to more profitable and efficient users. Corporate reorganization through mergers, acquisitions, divestments, and restructuring are the means (and plant closures and job losses are the transitional costs) of achieving economic flexibility, the carrying through of the process of ‘creative destruction’ which Schumpeter(1950)saw as necessary for technological progress and economic growth. Hence,for example,in Jensen’s analysis(  of the growth of shareholder value in the USA, excess capacity in the American tire industry in the 1980s led to takeovers and restructuring, with 37 tire plants closed between 1977 and 1987 and a decline of over 40 percent in employment in the sector: ‘[t]he pattern in the US tire industry is repeated elsewhere among the crown jewels of American business’. Merger and acquisitions activity in the USA in the 1980s was seen as a necessary—and highly successful—response to the declining productivity and profitability of American industry in the 1970s. Oil price rises and Japanese competition made such reallocation necessary. The positive stock market returns of companies involved in merger and acquisition activity were interpreted by Jensen and other finance researchers as indications of the positive contribution of such corporate restructuring to economic growth and overall social welfare.
However, the evidence for the overall positive contribution of merger and acquisition activity to shareholder value and performance enhancement is controversial   concluded that ‘there are substantial gains to shareholders from takeovers but virtually all the gains accrue to the target’. Despite rhetoric and ideology, it is questionable whether underperforming companies are the primary targets for merger and acquisition. Targets look to be average, or slightly below average, performers in comparison with other quoted companies’. In the USA, there is more evidence of underperformance leading to hostile acquisition . Mergers and acquisitions lead to improved stock market returns, at least for the target company, but the effects on long-term value creation are more doubtful .
There are four major grounds for questioning the special effectiveness of capital markets as a means of bringing about economic restructuring. First, capital markets may be more efficient in allocating resources away from unprofitable uses than in assessing and building new capacity. Following the principles of bounded rationality, the costs of assessing the profitability of   existing activities are lower than the costs of assessing the potential profitability of future activities, since there are higher levels of uncertainty, higher levels of risk, and higher information costs in assessing the future than the past or present. Judging the past, including past errors, is easier than assessing the future. Second, resources diverted from industries with excess capacity may be channelled into different but equally unproductive uses, such as conspicuous consumption or military expenditure, replacing ploughshares with swords.
Third, the analysis neglects the role of herding in stock market decisions. The movement of capital from wasteful to productive uses via the market for corporatecontrolandcorporaterestructuringassumesrationalcapitalmarket behaviour. However, the market’s herd instinct may lead to erratic investment patterns, as with the growth of investment in Internet stocks in the USA in the 1990s which led to the dot-com boom and subsequent slump,herding fuelling speculation and exaggerating volatility . The growth of index-tracking funds and the mechanics of fund managers’ reward systems tied to performance against the index may further accentuate herding tendencies . Moreover, the herd is more likely to be running the last race, not the next one. Finally, differences in perspectives, limitations in information, and high monitoring costs restrict the market’s capacity for evaluating innovation potential. Limited technological knowledge and difficulties in evaluating the comparative efficiencies of production processes restrict the market capacity to judge the value of investments in process innovation. To the extent that firms rely upon securing capital via equity investment, investment is more likely to be skewed to firms demonstrating high levels of product innovation than to firms investing in process innovation. Ceteris paribus, under shareholder value, the market is more likely to invest in high rather than medium technologies, in pharmaceuticals rather than cars.

The justification for viewing the market for corporate control as an efficient mechanism for allocating resources from less to more valuable (or at least more profitable) activities is therefore questionable. There are alternative external means of monitoring performance, preventing the entrenchment of management interests and reallocating resources amongst sectors. Alternative methods include political regulation and the operation of product and factor market constraints. The advocates of shareholder value argue that capital markets are more efficient than other external agencies because they are more economically rational than political actors and more timely than product or factor markets . We are sceptical of this conclusion. The economic and social costs of restructuring may be regarded as an inevitable consequence of economic change, independent of the means for carrying through such changes, whether capital markets, product market competition, or political decision-making. The reallocation of resources amongst sectors is socially and economically disruptive, whether the process is undertaken via the capital market, factor markets, or political decision-making.

The third efficiency justification for shareholder value is the role of the capitalmarketinsourcingcapitalforneweconomicactivities. Theoverallrole of the equity market is to channel investment into profitable productive activities, as Adam Smith (1976) noted. However, it is easy to exaggerate the economic significance of equity investment. The extent to which firms rely upon the equity market, debt, bonds, or retained earnings differs amongst countries and amongst sectors. Firms seek to minimize control costs in securing finance for new investment, leading to a pecking order of funding preferences, with retained earnings being the preferred mode of funding, followed by debt  . Even in capital market-oriented systems, such as Britain and the USA, the major source of capital for new investment is retained earnings  .
The preference for retained earnings followed by debt and bonds, rather than equity, is especially strong in countries where relationship banking is the norm. Even in Britain, for investments in R&D, firms prefer debt to equity, except for firms with very high levels of expenditure on R&D, such as pharmaceuticals. ‘In aggregate, the UK and US stock markets contribute virtually nothing to total sources of finance of industry’ .Share issues are more frequently used to fund acquisitions and mergers than for investment in new production facilities: ‘the stock market has primarily been a mechanism for the transfer of existing claims on real resources rather than a channel for funds to facilitate new investment in the corporate economy’  . There are of course specific contributions. The venture capital market is a major source of capital for new firm creation, even if only a small proportion of total capitalization.

The fourth efficiency justification for shareholder value is its encouragement to investment in high-risk new ventures. The venture capital market provides capital for investment in new sectors, such as IT and biotechnology, as well as in innovative service organizations. High returns and significant control rights are the rewards for undertaking high-risk investments. Venture capital–private equity funds acquire particular control rights and are heavily engaged in the development of the companies in which they invest, as shown in Chapter 5. Venture capital investment contracts typically provide for investor exit strategies after five or ten years, safeguarding investors’ commitments whilst reassuring entrepreneurs of their eventual return to control. The prospect of large financial rewards, safeguarded by control mechanisms protecting against downside risks, encourages investment in high-risk businesses and new firm development amongst both investors and potential   entrepreneurs. The prospect of large potential rewards from high technology ‘spin-out’ companies has encouraged academic researchers to focus on the possible market value of their research.

The venture capital market fosters innovation, especially in sectors where innovations are clearly identifiable and the returns to innovation easy to appropriate. Venture capital markets are especially effective in biotechnology and pharmaceuticals, where strong patent protection (at least in the USA, the major market) ensures that firms can appropriate the rents from innovation. However, capital markets are less efficient means of financing innovation where innovations are difficult to isolate and identify and returns difficult to appropriate, for example where patent protection is weak. Moreover, the frequency of legal challenges in pharmaceuticals and the de facto erosion of national patent protection by governments as well as competitors indicate the fragility of patent protection  .

The impact of shareholder value on process innovation is less positive. Shareholdershaveanaturalpreferenceforprofitdistributionratherthanearnings retention, a preference reinforced when academics reinterpret earnings retention as a licence for managerial extravagance.  the major requirements for innovation are knowledge and money, and that knowledge and money are more likely to be available in firms oriented towards internal controls and the internal allocation of resources than in firms oriented towards external, market controls: ‘[i]n combination, financial commitment, organisational integration, and strategic control support organizational control in contrast to market control over the critical inputs to the innovation process’. Internal focus and internal funding are associated with investment in process as well as product innovation, frequently involving incremental changes in production processes, an aspect of learning by doing. Toshiba’s development of plain paper copiers is a classic example of this process, involving close links between plant-level organization, process innovation, and new product development  . The benefits of such innovations are more difficult to appropriate, or sometimes even to identify, than product innovations, and are likely to escape the attention of capital markets. Process innovations are especially significant in medium technology enterprises, such as car manufacture, rather than high technology enterprises, especially where quality of manufacture is a source of competitive advantage.

The double-edged impact of competitive equity markets is evident in the development of the US computer industry. On the one hand, the US computer industry was highly successful in the 1980s and 1990s in launching new products in IT, with ‘Silicon Valley’ as the ‘entrepreneurial seedbed’ for new companies creating software and, to a lesser extent, hardware for Internet companies . Venture capitalists  played a central role in this development. On the other hand, US equity-financed IT companies were single sector companies which dominated specific niches, but did not build large-scale manufacturing capacity to exploit the advantages acquired by being first mover. This contrasted with the earlier route to international dominance of consumer electronics by Japanese companies, and the route to continuing challenges to US computing dominance by Japanese computer manufacturers. The rise to international dominance by the Japanese consumer electronics industry was due to long-term capital accumulation and the learning capabilities of major Japanese firms such as Mitsubishi Electrical, Fujitsu, and Toshiba, which had their roots in the electrical and telecommunications industries established before the First World War. Such firms had grown into consumer electronics from related sectors, cumulatively developing their learning capability. This pattern of growth through diversification into related sectors over an extended period was financed by retained earnings and debt financing, not by raising funds in the capital market. This long-term, expansive growth contrasted with the narrower, sector-specific and focused development of the US industry. Hence, ‘the multi-sectored, multi-industry enterprises have more of the organizational capabilities and income to commercialize products of new technologies and to enhance products of existing technologies than do the single sector enterprises’  .

The competitive capital market mechanisms which encouraged rapid product innovationdiscouragedaspotentiallywastefulthecapitalaccumulationwhich fostered cumulative learning, incremental innovation, related diversification,
and growth in market share.

The fifth strand in the efficiency justification for shareholder value relates to the role of incentives. The anticipation of future benefits from profit distribution or capital appreciation is, of course, the initial incentive for investors. The allocation of control rights to investors is the means of protecting investors against the expropriation or misappropriation of their resources by managers  . However, control rights are an inadequate basis in themselves for protecting investors’ interests, because of the incomplete character of investor–manager contracts, and the operational need for managerial autonomy and judgement. Shareholders therefore need to align the incentives of senior managers with those of investors. Without external monitoring and alignment of investor and corporate management interests, managers’ incentives may be distorted, with the extravagant mismanagement, even expropriation, of corporate resources through institutional empire building, excessive staffing, and overgenerous compensation schemes.
Managers have strong incentives to prioritize corporate growth, even at the   expense of profitability. Senior management share options, like bonus schemes, are sticky downwards, rewarding success in meeting targets but rarely penalizing failure; the downside risks for senior managers are small. The modus operandi of share option schemes usually allow managers to benefit from increases in share prices which derive from favourable macro-economic circumstances or product demand changes (such as raw material or energy price rises), whilst guarding against the negative consequences of unfavourable environmental changes, such as exchange rate fluctuations. Moreover, the wide discretion available to senior managers in developing share option schemes, and the loose constraints often imposed by remuneration committees, may result in self-dealing and overgenerous option arrangements, even if the ‘misdating’ of option entitlements is only a minority practice . It is not surprising that much of the initiative for the development of share option schemes came from managers rather than from shareholders.

The finance literature has focused on the complexities of share option schemes, consistent with its preoccupation with problems of agency. However, the interests of investors and senior managers are relatively similar, as wealthy high-income earners, except in the specialized world of principal– agent theory. More problematic is the impact of shareholder value and share option  schemes on the incentives of other stakeholders in the firm.

Prioritizing the interests of investors and focusing on the incentives of senior managers inevitably marginalizes the interests of other stakeholders, especially employees, with obvious negative effects on their incentives. One mechanism for aligning employees’ incentives with those of investors is through the adoption of employee share ownership programmes (ESOPs) or similar programmes, fostering an investor orientation amongst employees  . However, the scale of ESOPs is much smaller than the scale of share options, their coverage more limited, and their levels of reward far less generous. Their incentive effects are therefore limited. Providing incentives for employees to commit to the corporation and to invest in the development of their own human capital may be important, particularly for firms operating in knowledge-intensive sectors of the economy, but its importance is rarely recognized by senior management. Moreover, customers and clients may be discouraged by the approach of firms that so explicitly give higher priority to the interests of others.

The primary concern of shareholder value is with issues of distribution, with the efficient control and equitable distribution of corporate assets and income streams, within the framework of agency theory. This focus on issues of distribution inevitably neglects production concerns. This neglect has negative, rather than benign, consequences for the firm. Giving priority to minimizing transaction costs leads to difficulties in developing production systems which involve high levels of integration, and with a focus on organizational learning, including the transmission of implicit knowledge .

Integration may involve increasing transaction costs, with complex and even redundant linkages which foster understanding and organizational learning throughout the production system, rather than skill acquisition and learning targeted at specific objectives. Effective integration may involve increased communication costs, including communication redundancy, to provide for organizational learning and innovative responses to unanticipated external changes. Japanese success in manufacturing rests on such organizational learning and the close integration of product development and manufacturing .Effective integration involves investment in developing employee skill levels, not only the strict application of engineering principles and cost–benefit analysis.

The fluidity of capital markets enabled the rapid development of new, high technology sectors and revitalized established sectors. However, O’Sullivan  argued that the relationship between investors and managers in the USA does not provide a good environment for the development of the organizational learning and cumulative innovation seen as requirements for competitive ‘middle technology’ companies. The emphasis on shareholder value led to ‘downsize and distribute’ rather than ‘retain and reinvest’ practices.

The theories of principal–agent gave too much attention to issues of entitlement and distribution and too little attention to production and, especially, innovation. Moreover, the success of ‘Wintelism’—new production systems based on combining central control of design and branding with outsourcing of production to specialized component producers—did not provide the basis for sustainable prosperity.Design innovations could seep to competitors, component producers could evolve ‘downstream’,and consumer brand loyalty could prove fickle.

The negative implications of applying shareholder value logic for productive efficiency are especially evident in organizations seeking to develop highperformance work teams. High-performance work teams require high levels   of trust, with team members relying on one another to operate flexibly and to use their initiative and intelligence to contribute to innovation, as well as to respond constructively to unpredictable environmental changes. However, prioritizing measures to control self-dealing inevitably corrodes trust and fosters a low-trust dynamic, in which management attempts at control foster the behaviours management is seeking to avoid, such as ‘self seeking with guile’   as well as organizational ‘misbehaviour’ and outright resistance  . Many modern production systems require the teamwork and flexibility fostered by the high-trust dynamic, which is difficult to reconcile with the transaction cost-minimization focus fostered by shareholder value.

The limitations of the efficiency justifications for shareholder value reflect problems with its basic underlying assumptions. There are two sets of questionable assumptions. The first set relates to the conception of the firm. The second set relates to the psychology of economic actors.

 

Theories of shareholder value operate with a specific conception of the firm, as a network of ego–alter relationships analysed in terms of ends–means linkages—the firm is conceptualized as a ‘nexus of treaties’.The firm is a particular type of market, ‘the outcome of a complex equilibrium process’  involving interdependence and exchange relationships amongst the parties. This deconstruction of the firm into networks of principal–agent relations represents an under-theorized conception of the firm, neglecting the significance of institutions as social constructs—an ‘under-socialized’ conception of the firm. The firm has an independent corporate existence, not capable of decomposition into a nexus of treaties. This is recognized in the legal status, the legal personality, of the corporation. Corporate assets are held by the collectivity as a social organization, independently of the interests or wishes of individual shareholders. the organic model of corporate behaviour—which gives to the corporation life independent from its shareholders—describes the actual behaviour of large companies and their managers far better than does the principal–agent perspective, and…this is as true in Britain and the United States as it is in Japan .Indeed, the Japanese conception of‘the new community firm’ does not even include the shareholder as a member of the community  . The board of directors is the legal guardian of corporate assets, whose legal obligations include acting as stewards on  behalf of the company, not only as representatives of the shareholder interest.
The dual nature of directors’ obligations, to the corporation as an entity and to the shareholders of the corporation, is reflected in US legal conceptions. The business judgement rule protects corporate management and limits the scope of shareholders’ legitimate concerns. This duality and the good business judgement defence have been repeatedly underlined in the decisions of the Delaware Supreme Court, the jurisdiction in which the majority of major US corporations are registered.
The second set of assumptions relates to the motivations of economic actors. As in transaction cost economics, agency theory operates on the assumption of agent opportunism. There is an inherent conflict of interest between principal and agent, which principals seek to manage.  As agents, corporate management are motivated to behave opportunistically, contrary to the interests of their principals. Where continuous monitoring and sanctioning by principals is impossible and contracts are incomplete, as in relations between investors and managers, special incentives are required to transcend the agent’s propensity for self-seeking.

The ‘relentless application of calculative economic reasoning’ may generate interesting models and researchable hypotheses, as Williamson claimed, but has negative behavioural consequences when used as a basis for management action. The assumptions about motivation echo a long-standing tradition in management thinking, well summarized in Douglas McGregor’s ‘Theory X’ (1960): self-interest is the only reason for action, and monitoring and control, or at least insurance, is necessary to deal with the risk of malfeasance.However, operating according to the assumptions of ‘Theory X’ fosters mistrust and generates a low-trust dynamic, in which measures to counter the costs of anticipated malfeasance accelerate the decline in trust.The low-trust dynamic involves a cycle of increasing control, psychologicalwithdrawal, lack of cooperation, and competitiveness amongst individuals. Attempts to control malfeasance thus result in a self-fulfiling prophesy. In line with expectancy theory, anticipating treachery is likely to produce treachery.

The justification for shareholder value rests more heavily on efficiency than onequityconsiderations.Theequityjustificationforshareholdervaluederives from the unsecured status of the investor’s contribution to the corporation. Shareholders’ returns are not protected by contract, unlike the returns of other stakeholders, such as employees and creditors. Shareholders are residual claimants and bear the risks of the corporation’s losses, and therefore merit prioritization in the allocation of rewards. Moreover, as residual claimants, shareholders have the strongest incentive to optimize the performance of the corporation, since their rewards depend directly on the size of the residual.
However, stressing the risks of shareholders over the risks of other stakeholders downplays the significance of the risks of other stakeholders. The returns of bondholders are also sensitive to the performance of the firm. Moreover, employees may also have made investments in acquiring knowledge and skills specifically relevant to the firm, with no guarantee of return.
There are thus flaws in both the efficiency and the equity justifications for shareholder value. With regard to efficiency, the shareholder value analysis exaggerates the weaknesses of internal control systems, overestimates the efficiency of the capital market as a means of transferring resources from sectors of low value added to sectors of high value added, and attributes too much importance to the capital market and equity finance as a source of new capital investment, even for high-risk ventures. Shareholder value advocates are also sanguine in their assessment of share options as a means of aligning the interests of managers with those of shareholders, since share options are a means of increasing the rewards of managers as much as a means of aligning managers’ and shareholders’ interests. With regard to the equity justification for shareholder value, highlighting the role of shareholders as the sole bearers of unsecured risks neglects the risks experienced by other stakeholders, especially employees.

INVESTOR ENGAGEMENT
What are the justifications for investor engagement? What direction should the reform of corporate governance take regarding investor engagement?
There are three major categories of justifications for investor engagement.
Shareholder Value, Investor Engagement, and Management Practice a means of enhancing shareholder value. Investor engagement is a means of advancing investors’ interests and of maximizing shareholder returns, alongside other policies and practices such as mandatory codes of practice in corporate governance, transparent corporate reporting, standardized accounting procedures, and strong legal protection for shareholders’ property rights.
There is consensus in shareholder value regimes on the appropriateness of investor engagement as a means of maximizing shareholder returns, directly or indirectly. The origins of shareholder activism in the USA, associated especially with CalPERS, lay in this form of investor engagement. CalPERS’ shareholderactivisminvolvedsponsoringshareholderresolutionsagainstcorporate anti-takeover devices, supporting shareholder resolutions on corporate board restructuring.
Corporate governance reform has been primarily concerned with this form of investor engagement, as a means of protecting shareholder interests and enhancing shareholder value. The major objective has been to prevent the expropriation or misappropriation of investors’ assets by corporate management. Corporate law reform has been targeted at the protection of private property rights. International comparative research has suggested the greater success of common law jurisdictions than of civil law jurisdictions in supporting private property rights, leading to enhanced interest in the dynamics of common law jurisdictions  . The major strategies for preventing management expropriation include strengthening the authority of independent directors on company boards, ensuring timely, transparent accounting information, and developing an informed critical business media . Investor engagement is a significant means for carrying such strategies through at corporate level.

The major difficulty perceived in pursuing such objectives through investor engagement is the free rider problem.   The costs of investor engagement in time and money are particular, whilst the benefits of engagement are universal, the improvement of corporate governance. However, mechanisms exist for sharing the costs of engagement, with collective action through organizations such as NAPF or ISC as well as through ad hoc arrangements. Moreover, some of the costs of the monitoring required to support investor engagement are covered by public interest organizations and the business media, as well as regulatory bodies; the Wall Street Journal played a significant role in highlighting corporate scandal at Enron. The costs and practical difficulties arising from the free rider problem can easily be exaggerated.

The second category of justifications for investor engagement is that of securing corporate conformity with ‘best City practice’. This involves going beyond the specific objective of maximizing shareholder value in the individual corporation to using investor engagement as a means of ensuring compliance with collective norms of behaviour. Such ‘best City practice’ may go beyond following the formal codes of practice or complying with stock exchange listing rules. From this perspective, investor engagement is a means of upholding the norms of good corporate behaviour. The norms include opposition to corporate tactics designed to restrict competition for corporate control, such as multi-class share structures, support for genuinely independent non-executive directors, and limitations on the remuneration levels of senior executives, especially in badly performing firms. Previous chapters have included examples of investors mobilizing to ensure compliance with ‘best City practice’, as with the opposition to remuneration practices at J. Sainsbury plc and GSK in 2003 and 2004. Investor engagement may also be used to transfer best practice internationally, for example through the transfer of venture capital practices from ‘Silicon Valley’ to Britain . Atanormative level,such investor engagement is not controversial, although previous chapters have indicated the practical difficulties involved in its realization.

The third type of justifications for investor engagement is its use as a means for achieving broad economic and social objectives, including CSR. The specific justification for investor engagement in relation to broad economic and social objectives derives from investors’ responsibilities as ‘universal owners’.
As universal owners, institutional investors, especially pension funds, have responsibilities for the long-term welfare of their beneficiaries, and concern for the negative externalities of the actions of the firms in which they invest.
This obligation is reinforced by market factors, the difficulty of universal owners disinvesting without having a negative impact on share prices.

The force of this justification for investor engagement is enhanced by the absence of alternative influences on corporate management, with the weakening of collective employee organization, and the defensive ideological stance of public authorities towards business interests. The global CSR movement is seeking to push corporate practice towards such broader conceptions of corporate responsibility  . In this framework, investor engagement may be justified as an extension of enlightened shareholder value. The broader issues raised include environmental concerns and global climate change, as well as sector-specific issues such as low-price drugs for developing countries in pharmaceuticals, or discrimination issues, such as hiring practices for minorities. However, the use of investor engagement as a means of achieving such social objectives seriously undermines   the shareholder value model. It blurs the clarity of corporate objectives: one investor’s enlightened self-interest might be another investor’s irresponsible extravagance. Moreover, the adoption of broader objectives may undermine the collective unity of investors’ organizations, reducing their effectiveness in seeking to influence corporate management. Different institutional investors have different views on social and political issues, even where they agree on maintaining ‘best City practice’. In the USA, the courts have restricted the scope of investor activism and reinforced corporate management by regarding one of the major social issues of concern, minority hiring practices, as covered by the principles of the ‘good business judgement’ rule and therefore the responsibility of corporate management, outside the range of legitimate investor interest.

The stakeholder conception of corporate governance was conventional wisdom in Britain and the USA in the late 1970s. However, the conception subsequently lost favour, with the rise of shareholder value. The equity justification for recognizing the interests of multiple stakeholders is that several stakeholders,not only investors,makefirm-specific and only partially transferable commitments to the corporation. All such stakeholders could justifiably expect recognition of,and compensation for,the risks involved in making such commitments. In particular, employees make long-term firm-specific commitments, through the investment of time and effort in acquiring skills that may be transferable to only a limited extent  . The efficient development of the firm’s productive capacities requires employees to invest in acquiring such skills. Moreover, for employees, as for managers, participation in the ownership of the firm is an incentive for corporate commitment,as recognized in the development of ESOPs.

The power and influence of different stakeholders in the corporation depend on the external context, including the macro-economy and product and labour markets, as well as the institutions of corporate governance. Firms, as well as governments, require flexibility to respond to changing circumstances. But institutional protection—‘flexible rigidities’  — may be required to prevent the interests of weaker groups from being swept away. The influence of shareholders as owners, employers, and employers’ organizations is currently dominant, buttressed by shareholder value corporate governance arrangements in Britain and the USA. The dominant ‘distributional coalition’  is between owners and corporate management. However, other distributional coalitions are feasible, such as between employees and managers against owners, rather than managers and owners against employees. The likelihood of such a coalition depends on political as well as economic conditions. Indeed, Austrian and Scandinavian corporatist models resulted from a distributional coalition between managers and employees . In different historical circumstances,institutional protection may be required for shareholders’interests even  The power and influence of different stakeholders in the corporation depend on the external context, including the macro-economy and product and labour markets, as well as the institutions of corporate governance.
Firms, as well as governments, require flexibility to respond to changing circumstances. But institutional protection—‘flexible rigidities’  — may be required to prevent the interests of weaker groups from being swept away. The influence of shareholders as owners, employers, and employers’ organizations is currently dominant, buttressed by shareholder value corporate governance arrangements in Britain and the USA. The dominant ‘distributional coalition’   is between owners and corporate management. However, other distributional coalitions are feasible, such as between employees and managers against owners, rather than managers and owners against employees. The likelihood of such a coalition depends on political as well as economic conditions. Indeed, Austrian and Scandinavian corporatist models resulted from a distributional coalition between managers and employees  . In different historical circumstances, institutional protection may berequired for shareholders’interests even in Britain and the USA.For example,shareholders   may face expropriation by an alliance between managers (perhaps supported by block holders) and employees, under the guise of protecting national strategic interests. Moreover, it is not in the interests of dominant coalitions to sweep the losers from the field (especially if the game is to be repeated).

 

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