Revision on Business Ownership and Control
Agitators for change …Now is the season of their discontent.
In A2 microeconomics you will have been taught about the Principal-Agent problem. This relates to the
divorce between ownership and control in modern corporations, a situation where the shareholders in a
business may be some distance from the senior and middle management who make most of the day-to-day
decisions on pricing, investment and other aspects of business strategy.
Many investors in a business are 'passive', they might monitor the performance of the corporation by following
the news in the financial press and (occasionally) attending and voting at annual general meetings but their direct
involvement is limited and unlikely to have a bearing on the crunch decisions of the business. The biggest
investors in UK listed companies tend to be large institutional shareholders such as pension funds and
insurance companies.
This divorce can mean that the managers (agents) might take decisions that vary from the objectives of the
owners. This has given rise to various behavioural theories of the firm which place greater emphasis on nonprofit maximising behaviour - for example, pursuing faster growth of sales revenues or aggressive pursuit of
market share - perhaps at the expense of a narrow focus on maximising shareholder value through profit
maximisation.
But how valid is this view?
Increasingly we are seeing a new breed of shareholders who are seen to be much more proactive in putting
executive management under pressure - these are known as activist shareholders. At the forefront of this
change has been the expansion of private hedge funds and a number of high profile and very wealthy private
investors. Latterly, the sovereign wealth funds have appeared on the scene.
An activist shareholder uses an equity stake in a corporation to put pressure on its existing management. The
goals of activist shareholders range from financial (increase of shareholder value through changes in dividend
decisions, plans for cost cutting or capital investment projects etc.) to non-financial (dis-investment from
particular countries with a poor human rights record, or pressuring a business to speed up the adoption of
environmentally friendly policies and build a better reputation for ethical behaviour, etc.). Activist shareholders
do not have to hold large stakes in a business to make an impact. Even those with relatively small stakes or 3 or
4 per cent can launch publicity campaigns and make direct contact with the senior management. Private equity /
hedge funds have been among those most involved in the rise of shareholder activism. They tend to focus on
under-performing businesses
Is this new breed of shareholder activists an important voice and counter-balance to the power of entrenched
management and willing to stand up to corporate corruption and highlight poor management? Can they help to
overcome the principle-agent problem? Or are they merely aggressive corporate raiders seeking short-term
corporate change merely for their own personal gain?
Examples of shareholder activism
Sainsbury's: In 2004, a third of J Sainsbury's shareholders voted against the supermarket's pay policy, objecting
to its decision to give a £2.3m bonus to ousted chairman Sir Peter Davis. Sainsbury's subsequently decided to
cancel the controversial pay award. Sir Peter Davis quit Sainsbury's after a group of major institutional
shareholders demanded management changes. He was replaced by Justin King.
Disney: In 2004, Michael Eisner, the chairman and chief executive of Disney, resigned after 43% of Disney
shareholders voted against his re-election.
EuroTunnel: In 2004, the management board of EuroTunnel was ousted at the company's AGM.
Vodafone: In May of 2006, Vodafone announced the biggest loss in British corporate history (£14.9 billion). In
July 2006, the CEO of Vodafone Arun Sarin came under huge pressure from a group of shareholders unhappy
about the performance of the struggling telecoms company. In the event, shareholders voted 86% in favour of
Mr Sarin, with 9.5% voting against, and 4.5% abstaining.
Daimler-Chrysler: In April 2007, about 9,000 shareholders attended the German-US carmaker's annual meeting
and voiced strong criticisms of the businesses’ performance. Many shareholders stood up during the meeting to
condemn the transatlantic merger which took place between Daimler-Benz and Chrysler in 1998.
Motorola versus Carl Icahn: The billionaire financier Carl Icahn has a reputation as one of the leading
shareholder activists. He has been in a battle with Motorola over their strategy
Principals:
Shareholders
OWNERSHIP
Control Mechanisms:
Pressures from the stock market
and from hedge funds and private
investors
Regular meetings with
shareholders (e.g. the AGM)
Scrutiny in the financial press
Performance related pay (to
provide incentives)
Agents:
Board of Directors
Senior Management
CONTROL
Evaluation:
Modern businesses are exposed as never before to the scrutiny of the financial press and wider media, activist
shareholders, environmental groups, trade unions and consumers who have high expectations of what they want.
Whilst the majority of individual shareholders in modern corporations do play little or no direct role in the
running of a business, we should not underestimate the power of the financial markets to mark down the value of
shares in companies that are under-performing, or having to issue numerous profit warnings or whose wider
reputation for business acumen and social responsibility is now headline news on a regular basis. Ultimately the
market for corporate control – the stock market – remains a powerful weapon to focus the minds of executives.
Hedge funds and sovereign wealth funds have altered the picture to the extent that the classic distinction between
ownership and control has now become blurred in many cases. Shareholder revolts are becoming more common.
In the next revision note we will look at alternatives to profit maximization.