BUSINESS ETHICS AND CORPORATE GOVERNANCE. Prof. Stefania Servalli. Corporate Governance

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1 BUSINESS ETHICS AND CORPORATE GOVERNANCE Prof. Stefania Servalli Corporate Governance 1

2 CORPORATE GOVERNANCE MODULE (6 credits) Prof. Stefania Servalli (coordinator) 6 credits 48 hours: 8 hours Stefania Servalli 16 hours Roberto Aprile 16 hours John Ferguson 8 hours Louise Crawford 2

3 CORPORATE GOVERNANCE MODULE (6 credits) Prof. Stefania Servalli (coordinator) 6 credits 48 hours: 8 hours Stefania Servalli: Th ; Fri :30 16 hours Roberto Aprile: Fri :30 (*) 16 hours John Ferguson week starting 4 th April 8 hours Louise Crawford week starting 11 th April (*) a part from 25 th February Thursday

4 Corporate Governance & Accountability Papers and slides indicated by Professors (included Visiting Professors)

5 EXAMS BUSINESS ETHICS AND CORPORATE GOVERNANCE 22/01/16 h. 9,30 [31/03/16 h. 9,30 only Business Ethics] 06/06/16 h. 9,30 08/07/16 h. 9,30 05/09/16 h. 9,30 5

6 Why is CG Important? Weaknesses in corporate governance can lead to corporate failure Ongoing global financial crisis has emphasised the need for good corporate governance Corporate governance can affect corporate financial performance Corporate governance can affect social welfare

7 Ethical Issues in CG The social impact of poor corporate governance is substantial Examples: Executive remuneration is a SOCIAL issue not a financial issue Scandals: how could this happen? manipulation of the LIBOR rate (UK) some Italian banks in trouble (Italy)

8 What is CG? There is no single, accepted definition of corporate governance Spectrum of definitions ranging from narrow to broad ones Narrow Broad

9 Narrow approach shareholder-oriented expressed in agency theory: E.g. The Cadbury Report 1992 (UK) Corporate governance defined as "the way in which companies are directed and controlled

10 Broad approach stakeholder-oriented expressed in stakeholder theory This approach has attracted a greater interest in recent years

11 Nevertheless Recent definition more closer to shareholder approach Walker, D. (2009), A review of corporate governance in UK banks and other financial industry As well as, early definition beyond shareholder approach Tricker, R.I (1984) Corporate governance: practices, procedures, and powers in British companies and their boards of directors, Gower, London.

12 So what? In the literature, different definitions of CG tends to have certain common characteristics Accountability Narrow approaches Accountable to shareholders Broad approaches Accountable to stakeholders

13 Jill Solomon CG definition The system of checks and balances, both internal and external to companies, which ensures that companies discharge their accountability to all their stakeholders and act in a socially responsible way in all areas of their business activity.

14 Shareholder accountability is not inconsistent with stakeholder accountability Max of value creation in the l.t. being accountable towards all stakeholders Good governance - successful financial performance Management quality

15 Theoretical Frameworks Different theoretical framework about CG AGENCY THEORY TRANSACTION COST THEORY STAKEHOLDER THEORY

16 Agency Theory The shareholder-oriented view Limited liability Separation of ownership and control US (Berle and Means, 1932) and UK (Prais, 1976) Principal and agents

17 Agency Theory Principal and Agents Principal = owner or anyone who hire someone else to do a certain job at their expense Agents = managers, a person hired to do a certain in exchange for an agreed compensation

18 Agency Theory PRINCIPAL -AGENTS Hill and Jones (1992) MONITORING EXPENSES AGENTS BONDING COSTS RESIDUAL LOSS

19 Agency Theory Monitoring costs Cost designed to limit opportunistic actions by the agents (incentive schemes and contracts) Bonding costs (ex ante) Cost to demonstrate the accountability by agents (extra information, meeting with primary shareholders) Residual loss Reduction of the principal welfare Monitoring and Bonding Costly!

20 Agency Theory How can shareholders control agents? voting at annual general meetings take-over mechanism passing of shareholder resolutions divesting (selling their shares) one-to-one meetings regulation or formal guidance Markets are not perfectly competitive and therefore intervention is necessary Since early 1990s 'voluntary' codes of practice and policy documents

21 Transaction Cost Theory Transaction Cost Theory: Coase (1937), The Nature of the Firm, Economica, New Series, Vol. 4, No. 16., pp Cyert and March (1963), Williamson (1996) Bounded rationality: Behavior that is intentionally rational but only limitedly so Opportunism: Managers are opportunistic by nature

22 Transaction Cost Theory Managers internalize transactions as much as possible Managers organize transactions in their best interest Need of control on managers

23 Agency Theory and Transaction Cost Theory A common need of control on managers Different lens to see the same problem: persuade managers to pursue shareholder s interests, profit maximization

24 Stakeholder Theory 1970s Freeman (1984) Hold a stake not solely a share in companies shareholders employees suppliers customers creditors local communities the environment animal species/biodiversity future generations

25 Stakeholder versus Agency Can companies maximize shareholder wealth AND satisfy a broad range of stakeholder needs? Problems of balancing needs of stakeholders Often different groups have diverse and contradictory needs and concerns

26 Stakeholder versus Agency There is: "... an ongoing struggle between economic views of the firm which are decidedly silent on the moral implications of the modern corporation, and ethicists who place the need for understanding ethical implications in a central role in the field of business ethics Shankman, N. (1999), Reframing the Debate Between Agency and Stakeholder Theories of the Firm, Journal of Business Ethics, Volume 19, Number 4, Page 319

27 Stakeholder versus Agency Shankman, 1999: stakeholder theory encapsulates agency theory Growing literature suggesting that a corporate approach considering a broad range of factors (social, ethical, environmental etc.) is positively related to financial performance.

28 The Enlightened Shareholder approach is based on a growing belief that: maximising stakeholder welfare/wealth leads to longterm value maximisation creating value for stakeholders is synonymous with creating financial value for shareholders ignoring the needs of stakeholders can lead to lower financial performance and even corporate failure: BP and the Gulf of Mexico! corporate social, ethical and environmental performance are indicators of management quality Adopted by the recent review of company law and the new version of UK company law

29 2010 BP Gulf of Mexico disaster

30 Enlightened Shareholder and Stakeholder inclusive approach The King Report III (2009) developed in South Africa is probably the most advanced set of corporate governance principles in the world Distinguishes between Enlightened Shareholder and Stakeholder Inclusive approaches

31 Enlightened Shareholder and Stakeholder inclusive approach It is recognised that in what is referred to as the enlightened shareholder model as well as the stakeholder inclusive model of corporate governance, the Board of Directors should also consider the legitimate interests and expectations of stakeholders other than shareholders. The way in which the legitimate interests and expectations of stakeholders are being treated in the two approaches is, however, very different: In the enlightened shareholder approach the legitimate interests and expectations of stakeholders only have an instrumental value. Stakeholders are only considered in as far as it would be in the interest of shareholders to do so. In the case of the stakeholder inclusive approach, the Board of Directors considers the legitimate interests and expectations of stakeholders on the basis that this is in the best interests of the company, and not merely as an instrument to serve the interests of the shareholder. King Report III, 2009

32 Corporate Social Responsibility Although Enlightened Shareholder represents an improvement on the Agency approach, we need to move on There is an urgent need for all society to address stakeholder issues: Human rights Treatment of employees Treatment of customers Climate change E.g: The Stern Report (2006)

33 Companies are pervasive in their impact on society and on the environment They have to be called to account for their actions They have to be accountable to society They have to behave responsibly Things are changing but is the change happening quickly enough?

34 Corporate Governance is about improving companies ACCOUNTABILITY to shareholders and to non-shareholding stakeholders Sustainable, accountable companies are the only means of ensuring a safe global environment for the future

35 Global Financial Crisis The collapse of banks around the world has been attributed partly to bad corporate governance excessive remuneration encouraging the taking of excessive risks poor understanding of risks by board members Inadequate risk management systems and systems of internal control

36 More causes: Bad boardroom ethics Lack of personal integrity Excessive greed among boardroom members Inadequate risk disclosures Lack of linkage between audit, internal audit, board

37 Who Suffers from Bad Corporate Governance? EVERYONE! People with savings People who hold shares People who have borrowed People who own houses People who pay taxes People who lose their jobs People who are retired University students, lecturers, schools Hospitals and patients Etc.

38 Learning Outcomes define corporate governance in a variety of ways explain the different theoretical approaches to corporate governance appreciate why corporate governance is an increasingly important issue for business at a global level References Solomon (2013),Corporate Governance and Accountability, Chapter 1.