TABLED Caring Shareholders Can (also) Add Value

Shareholders, after all, are the owners and directors are merely their agents – stewards of shareholder property – and much of what has been done in the name of corporate governance is implicitly for the benefit of shareholders. So, an interesting question emerges: while boards are accountable to shareholders, who are shareholders accountable to? Are there any responsibilities associated with being shareholder? Do shareholders care about corporate governance?
It is fair to assume that shareholders do care about corporate governance. The separation of ownership and control that characterises much of the nature of modern business means that management can make self-serving decisions at the expense of shareholders. Effective corporate governance arrangements should lead to scrutiny of management and better decisions, and so better outcomes for shareholders.
However, the relationship between corporate governance and business performance is complex and doesn’t easily lend itself to statistical validation. Consequently, there is little ‘scientific’ evidence that the costly corporate governance improvements are producing net benefits to shareholders in terms of improved performance. In the absence of framework for assessing the value of more governance regulations, there will be scepticism and lingering concern about who really benefits from the added cost.
Shareholders need framework through which they can evaluate the benefits of corporate governance. I offer the following:
• Evidence suggests the overall standard of corporate governance in this part of the world is relatively high. Few companies have failed because of poor corporate governance and there is no evidence of excessive executive compensation as paid in the United States.
• Increased emphasis on corporate governance is no guarantee of superior performance, or even profitability. Businesses occasionally disappoint and some fail, such is the nature of the competitive market.
• The real corporate governance issue is performance. The sum of wealth destroyed through fraud and other malpractice is drop in the ocean compared to what’s destroyed by poor performance.
• Three key inputs to superior performance are monitoring, evaluation and incentives.
It is debatable whether shareholders have benefited from recent corporate governance reforms. For example, Britain’s magazine The Economist (21 May, 2005 pp81-83) highlighted University of Rochester study which estimated that the net private cost of Sarbanes-Oxley reforms in the United States amounted to US$1.4 trillion. The article suggested the law of unintended consequences came into play and that the major beneficiaries of the reforms are the accounting firms which, by and large, represent the profession that was generally at fault in the scandals and which subsequently shaped the new legislation. According to the article, United States companies (shareholders) paid, on average, $2.4 million more for their audits in 2004 than in 2003.
There are no comparative figures for New Zealand and Australian companies but, there is no doubt boards generally spend considerably more time on corporate governance procedures than they did and, even though directors are working harder than ever, the emphasis on governance compliance crowds out discussion on other important topics. Anecdotal evidence suggests boards have become more risk averse. As one measure of this, debt level measured relative to balance sheet or market ratio is now lower across corporate New Zealand and Australia than at any time over the past 20 years. Consequently, boards may be less willing to support entrepreneurial activities (ie risk taking) for fear of failure. The term entrepreneurial board may become an oxymoron!

Shareholder Responsibilities
The failure of shareholders to behave like owners is arguably one of the biggest failings in the capital markets and indirectly in governance. Capital markets can’t function efficiently if shareholders accept de facto disenfranchisement of their powers.
A good deal of criticism is levelled at institutional shareholders which, unlike individual shareholders, have the muscle and power to make difference. Their passivity is puzzling. Perhaps the so-called ‘free-rider’ problem is to blame whereby institutions have little incentive to monitor/manage, given that monitoring is costly and is public good (everyone benefits). Or perhaps institutions don’t see themselves as ‘owners’, but as short-term investors – though even the term ‘investor’ may be stretching it. As the world’s most successful investor, Warren Buffett, famously put it: “We believe that according the name ‘investor’ to trading institutions is like calling someone who repeatedly engages in one-night stands ‘romantic’.”
Shareholder engagement is about constructively influencing the behaviour of companies so that shareholder interests are kept prime focus of their endeavours. This engagement should be evident in shareholders’ voting on motions before shareholder meeting. Today, less than 50 percent of shareholdings are voted at general meetings in Australia and New Zealand.
It may not be perfect, but the age-old agency problem of owners ensuring that managers act in their best interests can, I believe, be addressed through well-designed incentive contracts. If performance pay gives stronger incentives for the right behaviour, because the results of this behaviour are rewarded, then the value of monitoring to enforce the desired behaviour directly is reduced. So caring shareholders should focus on the nature of performance contracts and support contracts which incentivise superior performance.

Caring Shareholders
But perhaps the best example of the power and economic consequences of caring shareholders is found in the private equity industry.
A recent United Kingdom study, and similar study in Australia on labour productivity, showed how well, on average, businesses perform when there is private equity involvement. Private equity-owned companies grew employment by 20 percent in 2004 compared to national average of 0.6 percent. Sales in private equity-owned companies grew at twice the rate of the average of FTSE100 and FTSE Mid-250 companies, and private equity-owned businesses invested in the business at rate double that of widely owned public companies.
Interestingly, 78 percent of the companies with private equity investors viewed their private equity providers as more than just fund managers. They viewed them as caring shareholders.

• By Joseph Healy, managing director Institutional Banking, ANZ Banking Group.

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