Stakeholders and Their Influence on Corporate Governance, Lecture notes of Ethics

Download Stakeholders and Their Influence on Corporate Governance and more Lecture notes Ethics in PDF only on Docsity! ACC 205 – CORPORATE GOVERNANCE AND ETHICS Stakeholders and Their Influence on Corporate Governance Every organisation has stakeholders. A stakeholder has been defined (by Freeman 1984) as: ‘any group or individual who can affect or [be] affected by the achievement of an organisation’s objectives. An important part of this definition is that a stakeholder may: • be affected by what the organisation does • affect what the organisation does, or • both be affected by and affect what the organisation does. Companies have stakeholders. A stakeholder in a company is someone who has a ‘stake’ in the company and an interest in what the company does. A company must offer something to all its stakeholders. If a company does not give its stakeholders something of what they want, the stakeholders might cease to have an interest in it. All stakeholders in a company have some expectations from the company. If a company wishes to remain associated with its stakeholders, it must do something to satisfy these expectations. The expectations of different groups of stakeholders are not the same, and they are often inconsistent with each other. One of the objectives of corporate governance should be to provide enough satisfaction for each stakeholder group. Stakeholder groups in a company include: 1. The shareholders of the company: shareholders expect a reasonable return on their investment in the company. They may be able to influence what the company does by exercising their right to vote at general meetings of the company. 2. The company’s employees: employees expect a fair wage or salary, and often expect job security or career prospects. They can affect what the company does either positively (for example by being well-motivated and efficient) or negatively (for example, by going on strike, or demanding higher pay). 3. The directors and management of a company, who need to satisfy the expectations of both shareholders (for high profits and dividends) and employees (for high salaries). In addition, they have their own self-interests, for example in high remuneration and status. 4. Customers of the company 5. Suppliers of the company 6. Trade unions 7. Communities in which the company operates 8. The government 9. Pressure groups and activist groups, such as environmentalists ACC 205 – CORPORATE GOVERNANCE AND ETHICS CLAIMS OF STAKEHOLDERS Each stakeholder or stakeholder group in a company makes demands of the company and want the company to do something to satisfy these demands. These demands are known as ‘claims’. Shareholders want dividends and a higher share price, employees may want job security and higher pay, customers may want better quality goods at lower prices, and so on. It is not always possible to identify the claims of a particular group of stakeholders. Certain groups of stakeholders may not know that they have a claim against an organisation; others may know that they have a claim but do not know what it is and do not express it openly. This gives rise to a distinction between direct and indirect stakeholder claims. Direct Stakeholder Claims: these are claims made by stakeholders directly, with their ‘own voice’. For example, employees may make a direct claim for higher pay. Shareholders, customers, suppliers and (sometimes) local communities may express direct claims to the company. Indirect Stakeholder Claims: these are claims that are not made directly by a stakeholder or stakeholder group, but are made indirectly on their behalf by someone else. For example: Future generations have a claim on what a company does today, for example if the company’s operations are capable of preserving or destroying the environment, future generations will be affected. They are not yet alive and able to express their claims directly, and someone else has to think about their interests for them. A problem with indirect stakeholder claims is that it is not always possible to be sure that the stakeholders are being properly represented and their claims correctly expressed. After all, how can we be sure what future generations will want, or whether a terrorist group really does speak in the interests of a wider community? Stakeholder Influence A feature of corporate governance or strategic analysis in any company is the balance of power between the stakeholder groups and the relative power and influence of each group. The Mendelow Framework can be used to understand the influence that each stakeholder group has over a company’s strategies and actions. The framework identifies two factors that make up the strength of a stakeholder’s influence over a company’s strategy, actions or decisions: i. The power the stakeholder is capable of exercising, and ii. The interest that the stakeholder has in the particular issue, and how much the stakeholder cares about it. Influence over a strategy or action comes from a combination of power and influence: Influence = Power x Interest ACC 205 – CORPORATE GOVERNANCE AND ETHICS considerable influence over a company’s activities. The main issue with this categorisation is whether a company should acknowledge the claims of a stakeholder group (if it is legitimate’) or whether it should ignore them or oppose them (if the group is illegitimate). vi. Known and unknown stakeholders: A distinction can also be made between known and unknown stakeholders. Known stakeholders are those that the company knows about. Unknown stakeholders are those whose existence the company is not aware of. This distinction may be relevant when a company has operations that affect the environment, or is planning new activities that will have an environmental impact. The company will not necessarily be aware of all the stakeholders that will be affected by its activities – for example animals, insects, sea creatures. It may be argued that before implementing any new business strategy a company should carry out a thorough investigation in order to identify unknown stakeholders and consider the impact of its strategy on them. vii. Internal and external stakeholders: A widely-used distinction is between internal and external stakeholders. Internal stakeholders of a company are inside the company and a part of it. External stakeholders are outside the company and are not a part of it. Two insider stakeholder groups in a company are the equity shareholders and the directors. SHAREHOLDERS AND DIRECTORS The main stakeholder groups in a company are usually the shareholders and the directors of the company. The shareholders own the company and the directors are its leaders. The Shareholders: The influence of shareholders over their company varies with circumstances. In a small company the shareholders and directors might be the same individuals. In some companies, there may be a majority shareholder (controlling shareholder). A majority shareholder should be able to influence the decisions of the board of directors, because he has the power to remove directors who disagree with him. In quoted companies (stock market companies) the interests of shareholders are likely to be focused on the value of their shares and the size of dividends. However, the shareholders might have little influence over the decisions of the board of directors. The Directors: The board of directors is a significant stakeholder group in a company because they have the power to direct the company. Directors act as agents for the company and represent the interests of the company. • A board of directors consists of both executive and non-executive directors. Executive directors have executive responsibilities as managers in the company, in addition to their role as director. They are usually fulltime employees of the company. Non-executives are not involved in executive management and are very much ‘part time’ and in many countries ACC 205 – CORPORATE GOVERNANCE AND ETHICS (for example the UK and US) they are not company employees. Since executive directors combine their role as director with their full-time job as company employee, their interests are likely to differ from those of the non-executive directors. • On the board of directors, some individuals might have considerably more influence than others. Typically, the most influential members of the board are the company chairman (board chairman) and the managing director (often called the chief executive officer or CEO). The board of directors take many decisions as a group, but they also have individual interests in the company. Directors are therefore stakeholders in their company both as a unit and as separate individuals. Other Internal Stakeholders Employees can be an important internal stakeholder group. It might be possible to divide employees into sub-groups, each with a different set of interests and expectations, and each with a different amount of influence over the actions of the company. • It might be appropriate to separate senior management and other employees into two separate stakeholder groups. Senior management might have a bigger interest in the profits and share price of the company because they belong to a share incentive scheme or share option scheme, or because they receive annual bonus payments based on the company’s profitability. Other employees who do not have such incentives will have much less interest in the financial performance of the company or its share price. • Some employees might be able to demand large rewards from the company or might exercise strong influence because of their value to the company. For example, in the UK some individual investment bankers have a strong influence within their bank because of the specialist skills they possess and the income they are able to earn or the bank. In some companies, there might be a strong trade union influence. The ability of a company to alter its working practices, for example, may depend on obtaining the co-operation and support of the trade unions. External Stakeholders: The External stakeholders are individuals or groups who do not work for the company but who nevertheless have an interest in what the company does and who might be able to influence the way in which the company is governed. i. Lenders have an interest in a company to which they lend money. They expect to be paid what they are owed. Usually a lender will not be closely involved in the governance or ACC 205 – CORPORATE GOVERNANCE AND ETHICS management of a company, but they will monitor its financial performance and financial position. Lenders will also become significant stakeholders if the company gets into financial difficulties and is faced with the risk of insolvency. ii. Suppliers have an interest in companies who are their major customers, although their influence over its governance might be small. iii. Regulators have an interest in companies whose activities they are required to regulate. Some aspects of regulation have a major impact on the way in which a company is governed. For example, quoted companies must comply with the rules set by the securities regulator (such as the Securities Exchange Commission in Nigeria, the US and the Financial Conduct Authority in the UK). iv. Government has a stake in companies. Companies are a source of tax revenue and also collect tax (income taxes and sales taxes) for the government from employees and customers. For some companies, such as companies that manufacture defence equipment, the government might have an influence as a major customer for the goods that the company produces. v. Customers, the general public or special interest groups might have a significant influence over a company, especially a company that relies for success on the high reputation of its products or services. vi. Stock exchanges have an influence over the governance of quoted companies, because companies must comply with the rules of the stock exchange on which their shares are traded. vii. A company’s auditors should also have some influence over the governance of a company, by making sure that the board of directors presents financial statements to the shareholders that present a true and fair view of the company’s financial position and performance. viii. Investors are a major influence over companies whose shares are traded on a stock exchange. Investors decide what the market price of a company’s shares should be. A company needs to satisfy the expectations not only of its shareholders, but of the investing community in general, if it wishes to sustain or increase the share price (and so the total value of the company). Institutional Investors Institutional investors are entities that specialise in investing, mainly in shares and bonds. There are several types of institutional investor. i. Pension funds: These institutions hold funds that will be used to provide pensions to individuals after their retirement. Pension funds may be sponsored by an employer, or may