Issues Between Owners

So far we considered shareholder activism as a question of rights.

Might it also be a question of wrongs?
 Whichever way we look at it one thing is clear,
shareholders do not always have the same interests. Advocates of
a shareholder-value-based approach to corporate governance
often assume that the formula for that value suffice, dividends,
plus capital gains, discounted by the time- value of money equals
shareholder value credited. When it comes to managing the
business to deliver that directors become aware of how different
some shareholders are from others.
The equity capital in a corporation arises from a number of
different starting points, taking a number of different paths.
 Private individuals may invest directly in the stock. They
maybe ordinary numbers of the public, but some may have
another connection to the company say as employees. Those
private individuals maybe more interested in dividend income
than capital gains or vice versa.
 Employee shareholders may be willing to sacrifice both for
the sake of keeping their jobs. Private individuals may also choose
to invest via collective investment s like mutual funds, in which case
a money manager acts as intermediary – as agent to the end-
investment, creating another layer of agency problems.
 Private individuals also save for the future through pension
funds, either by direct, defined contributions or through employer-
supported pension plans that promise to pay a proportion of fund
salaries or perhaps of average salaries earned during
employment. Pension plan trustees act as agent for the saver, and
while some invest directly, others employ specialist asset
management firms.
 Private individuals may also take out insurance policies,
perhaps life insurance but also casualty plans ad premiums obey
pay to insurance companies fund their way in part to equity
markets through insurance funds. Here the private individual is a
contractual beneficiary of the insurance company, but the
insurance is the principal of the investment. The insurance company
may have an agency relationship as well with pension funds, as
assurance funds often manage the assets of the pension industry.
 Corporations sometimes might make purely financial
investments in other corporations, not expecting a strategic
relationship. But such investments could also be strategic – the
basis for a long-term relationship, or the outcome of a cash
injection to facilitate research and development.
 Corporations also occasionally invest in other corporations
as a ‘spoiler’ or something like shark repellent knowing that one
company is already a big investor in the takeover targets might
deter another from building.
 Private equity funds are special cases of corporate
investors. These companies may work for wealthy individuals or
for asset management companies seeking to diversify their
investments. They may even be listed on a stock exchange
themselves. They typically invest in a public company for the sale
of taking off the stock exchange restructuring its operations and
then perhaps selling on to another company in the same industry
or even floating it on the stock market again.
 The Norwegian government uses its oil surpluses to fund a
generous state pension plan for all its citizens. More recently
China’s trade surpluses with the United States and other countries
have led to creation some enterprises to invest in equity markets
abroad. Traditionally they have acted just as any other asset
management firm; indeed, they have employed people with
experience in insurance or mutual funds to operate the business.
As government-owned entities, however there is always a
possibility their investments abroad could be directed for foreign
policy rather than purely financial aims.
 Sovereign wealth funds grew out of the rise in the surplus
income that some commodity-rich countries developed, money in
excess of what they could spend on economic development. Funds
like the Abu Dhabi Investment Authority or the Kuwait Investment
Authority placed their national oil wealth in large investments in
individual companies as well as spreading other funds widely to
the stock market.
 Investors who buy shares in companies might be share
similar shares for good financial performance from the company.
But it is not that way. Investor interests vary over three dimensions
– attitude engagement and horizon – that can influence how they
view value.
•
 First consider their attitudes towards a stock. Investors may
be inclined at any markets accumulate, reduce or maintain.
Someone buying wants the lowest possible value for the stock,
someone selling wants the highest.
 Stock exchanges grew up to provide a market mechanism
to settle on the right price. But inside the boardroom of the
company in which they have invested, such differences in attitude
can occasionally affect policy.
 Second, shareholders differ according to their
engagement with the company in which they invest. Some take an
activist stance, choosing to influence corporate boards and
management through direct conversations. Others are walkers,
more inclined to sell their positions if they do not like corporate
policy than to seek it to change it.
 The third dimension on which investors can differ is their
investment horizon. Some funds are in general inclined to invest for
the long-term, whatever attitude they might have towards an
individual stock at the moment. They expect managements in
general to act, therefore, in the long-term interests of the
business, corresponding with the investor’s long term orientation.
Others trade frequently and are more interested, therefore, in
seeing better performance over the short-term.
 Stock lending and short-selling are often linked but they
do not have to be to create perverse situations in corporate
governance. For many years institutional investors have borrowed
and lent shares to each other. The process takes the form of a
repurchase contact, in which one investor sells the shares while
agreeing simultaneously to buy them back at a future time
 Having a big shareholder can bring benefits. Their interest
are large enough that it pays for them to keep a close eye on
management. Indeed, their monitoring can be seen as a
mechanism that allows other shareholders to become corporate
governance ‘free riders’, gaining the benefit of monitoring without
bearing the costs.
• Business angels
• Seed funding for small ventures, often by successful business
people taking a gamble on what they see as an interesting
idea. Takes larger stake, alongside owner-manager.
• Highly speculative, these might exit to a venture capital fund
or later stage. Horizon is long term, perhaps for life of a
small business.
• Venture Capital
• 1st or 2nd stage funding for new ventures. Takes larger stake,
alongside owner-manager.
• Exit sought, probably to IPO or private equity
• Modelled on early capitalist financiers but often by
aggregating investment of high-net-worth individuals or even
large asset managers.
• Horizon is long term, with possible early exit.
• Traditional Asset Managers
• Invest in companies listed on stock exchange, also in bonds,
real estate and other assets.
• Risk diversification means stake in individual businesses kept
at modest level.
• Holds and trades shares
• Through aggregating large volumes o savings, these investors
are together able to provide large amounts of capital. May
themselves be listed companies, private companies, attached
to insurers or pension funds.
• Most are long only, i.e. not engaged in short-selling, many have
statutes requiring them not to use leverage.
• Horizon maybe long and short, occasionally perverse through
stock lending.
• Private equity funds
• Similar with VCs, but with even larger sums available.
• May take a listed company off the stock market by buying all the
shares and taking while the company out of the public eye for a
while.
• Aim is often to restructure the business with a view to selling it on,
either into a trade buyer or by relisting the stock at a future date.
• Aggregate funds from private investors, traditional asset
managers.
• Often highly leverage, using large scale bank loans to boost
returns.
• Hedge funds
• A mixed category with differing investment approaches.
• Aggregate funds from high-net-worth individuals, increasingly
from traditional asset managers.
• Almost always highly leverages, often using derivative
instruments to hedge downside risk.
• Horizon can be very short-term – many funds engage in
trading, buying and then selling the stock within minutes or
even seconds.
• Some funds take a long-term horizon, but trade
opportunistically. Position sizes may vary from the small to
occasionally very large economic stakes in the companies,
through combinations of shares, options and other derivatives.
• Horizon can also be perverse through short-selling, stock
lending.
 The cases of Volkswagen/Porsche and Deutsche Borse
show just how fiery the disagreements between shareholders
can be, especially when some use financial derivatives and
leverage to fan the flames. In the case of Volkswagen, the
mixture of family tensions and government involvement in what
was once viewed as a strategic industry would raise complex
governance issues even without the addition of global
investment, hedge funds and the use of derivatives by Porsche
to exploit a loophole in German disclosure rules.
 Deutsche Borse might have gone ahead with its plan to
acquire the London Stock Exchange in a traditional way had not
the untraditional world of highly leveraged hedge funds
intervened. These differences in views between shareholders mean
that we can view corporate governance as a battle for power
over the resources of the company.
 The assertion of shareholder rights can be viewed as an
attempt of one of the shareholders – those with a stance that is
maintain in attitude activist in management and long-term in
horizon – to gain power not only over management but over
shareholders who are short-term in horizon and seeking to boost
the share price as quickly as possible, or those who are usually
long-term on horizon but at the moment inclined to sell that stock
at the moment.
 What we see developing is, therefore, the potential for
various conditions interests among shareholders that would
normally take different stances towards a company in which they
invest. Traditional asset managers will tend to work on a long-
term horizon, even if they may be inclined to turn over their
portfolios quickly, because they need to stay invested and across
a wide range of stocks to reduce the risk of portfolio as a whole.
 It is not surprising, therefore, to find common ground
between them over the broad purpose of the corporation the
creation of shareholder value. Some Marcists scholars go so far as
to say their common interests unite in such a way as to seek to turn
their investments into commodities to make the fund managers’
own products more reliable, irrespective of the best outcome for
the individual business in their portfolios.
 Though they once dominated the investment landscape –
especially in the UK – their influence is now warning. The rise in
institutional investment is equities in the US as well as the IK, for
example, has been largely a result of the growth of hedge funds.
Sovereign equity funds have growth in importance in all markets.
Their contribution to the rescue of the global banking systems