Corporate Governance

 

Corporate Governance

 

Shareholders are the owners of the company and it is important to remember that the maximization of their wealth is the prime objective of companies in the private sector. This is the underlying concept in the theoretical parts of this chapter. However, they are not only the groups within interest in the company and the interplay of factors in the governance of a company is a key concept.

Company stakeholders

 In practice, companies often have multiple objectives (both financial and non-financial) involving various stakeholders groups, which prevent the maximization of shareholders wealth. The different stakeholders groups in an organization were identified in 1975 by the corporate report (ASC) which dealt with their objectives and specific requirements from accounting information. Clearly, different users will look at the company in different ways, the objectives of organization have to be designed to satisfy their varying needs, with the conflict, and compromises will have to be made.

 We consider the interests of some of the stakeholder groups below

A) Banks and others

This group includes anyone who makes a loan or other financial accommodation available to an organization, examples being debenture-holders, finance companies, building societies and venture capitalists.

 The main concern of this group is the safety of the investment; lenders expect to get their money back within an agreed period and to make a profit. In order to maintain the safety of the investment they want to ensure that the level of debt to equity does not become too high, because increase in the level of debt increase the risk of insolvency of the firm, with the firm being unable to pay the required interest payments. Short-term lenders are especially concerned with the ability and willingness to repay the liability from cash generated by the business. Long-term lenders may place a restive trust deed or set financial guidelines, eg: a set proportion of working capital, in order to ensure their investment.

B)   Business-contract group (includes debtors and creditors)

This group includes suppliers, competitors and all other business affected by an organization’s activities. Their objectives include ensuring that the firm deals honestly, does not misuse any monopoly powers and pays its bills promptly within the terms of the trading agreement.

 The group will be interested in developing long-term strategic relationships and the continuity of trading opportunity with an organization, which is financially stable with minimal administration. Customers of the organization will be concerned with having a supplier who is reliable, and who provides a constant supply of the product of consistent quality with good, efficient service at a fair price. Customers will also be concerned with the level of service they are receiving, the value for money, and the safety of the goods they receive.    

 Competitors are also included in this group, and include those who may be interested in acquiring the business as well as those who are rival in trade. The group will require as much information about the company and its finance as possible, although the company will not wish them to have such information, and secrecy may conflict with the needs of other groups.  

C)   Public

The needs of the public can take many forms, eg: sections of the public may wish to see a restriction on contributions to political parties, charities or social groups, or a restriction on the business activities carried out with, or in, a particular country. Another example is where local residents are interested in the amount of investment and degree of control that an entity has in their own community and its ultimate effect on their local environment. When public money assists the enterprise, the public may wish to see the return in profitability, jobs and services.

 

D)  Government

The Government wish to ensure that the organisation adheres to the law pays the correct amount of taxes and other financial charges levied upon it by government bodies, and provide the statistical and other information required on order to ensure control over its own economic policy. The Government will also be interested in ensuring that the organization respects its social and environmental commitments.

 

E)   Financial Analysts and Advisor

This group will comment upon the progress, or otherwise, of the entity. In order to do so they will need the fullest possible information in whichever field their interest lies. Their requirements may mirror those of any of the other user groups. They will, however have the key objective of ensuring complain with accounting standards to provide for uniformity to the presentation of information and the easier comparison with other organizations.

 

F)    Employees and Management

Employees will be concerned with the remuneration they receive from the company, their working conditions and security of employment. They may also be concerned with other factors such as training and career development prospects within the firm; benefits in kind such as accompany cars, company pension and redundancy provisions and the potential for future expansion of jobs for themselves and their friends and families.

G)  Shareholders and Investors

Shareholders and Investors are obviously an important stakeholders group, being the owners of the business. In order to meet the needs of shareholders management must,

Ø Maximize their wealth (shown by the growth in share price and the payment of dividends).

Ø Achieve a specific level of earning, earnings per share and dividends per share. Note that some shareholders prefer high dividends and some prefer capital gains but the needs of the majority should be met as far as possible.

Ø Stick to a preset target for obtaining profitability represented by either, level of risk, return on investment and profitability in relation to competitor businesses and other investment opportunities will be expected to be at an appropriate level.

Ø Maintain the security of the shareholder’s investment. This includes considering the fact that shareholders have different risk preferences and thus prefer different levels of gearing.

Ø Satisfy the investor that the company has sufficient cash flow to accommodate its plans and avoid future potentially fatal liquidity problems.

Ø Give details of political, charitable ore social donations in order allow shareholders to decide whether the convictions of the management are in line with their own views. 

This is not an exhaustive list of management objectives in respect of shareholders interests and you may be able to think of several others. A company therefore has to know who its major shareholders are and what their objectives for the company are, and concentrate on achieving those objectives. Such knowledge would also help to explain recent price movements when shareholdings change hands, and might help in fighting off a takeover bid.

Companies may have only a few shareholders (private family company) or they may have many small shareholders (some of the privatized utilities). Advantages of having a large number of shareholders include a reduced risk of one shareholder obtaining a controlling interest, greater market activity in the firm’s shares and thus the likelihood of vast price movements caused by one shareholder selling his shares is also reduced and takeover bids are easier to frustrate. Against this, however, will be increased administration costs covering statutory requirements of information to shareholders, and it may be more difficult to meet all shareholder’s conflicting objectives.