Corporate Governance and Mechanisms to Manage Shareholder Relationships

Stakeholder management emphasizes the need for a company to consider the needs of all its stakeholder groups. It lays the structure for stakeholder groups to exercise influence, control, and protect their interest in a company.

Corporate governance lays the foundation for the legal, contractual, and organizational infrastructure that defines the rights and responsibilities of each group.

Corporate Reporting and Transparency

The principles of governance are fundamentally based on corporate reporting and transparency. The external shareholders can gain financial and non-financial information through annual reports and other company disclosures.

Investors can obtain a wide range of financial and non-financial data of a publicly traded company through various sources such as annual reports, proxy statements, corporate disclosures, investor relations resources, and others. This information encompasses details about the company’s operations, strategic goals, audited financial reports, governance framework, ownership configuration, compensation strategies, transactions with related parties, and associated risks.

Specifically, investors utilize corporate reports and information for the following purposes:

• To evaluate the performance of a company as well as its directors and managers.
• To make decisions regarding valuation and investments.
• To cast votes on crucial corporate issues or changes.
• To verify adherence to legal obligations stipulated in debt agreements.

Shareholder Mechanisms

Shareholders are motivated to protect their legal and contractual rights through various procedures that vary depending on businesses and jurisdictions. Some of these procedures are discussed below:

Shareholder Meetings

General meetings allow shareholders to participate in company-related discussions and vote on significant corporate matters.
Companies usually hold an annual general meeting (AGM) within a certain period after the end of their financial year. The primary purpose of an AGM is to present shareholders with a company’s annual audited financial statements, provide an overview of a company’s performance over the year, and address any shareholder concerns.

It is also possible for a company or its shareholders to convene extraordinary general meetings (EGMs) within the year. This should happen whenever significant resolutions requiring shareholder approval are proposed.

Ordinary resolutions require a simple majority of votes to be passed. These usually relate to the approval of financial statements and the election of directors and auditors. Special resolutions require a supermajority vote, such as 75% of the votes to be passed. Special resolutions are more material in nature. Examples include effecting bylaws amendments and voting on a proposed merger or takeover transaction.

Proxy voting allows shareholders who cannot attend a general meeting to authorize someone else to vote on their behalf. It is the most common form of investor participation in meetings. Minority shareholders tend to use proxy voting in an attempt to increase their influence in companies.

Cumulative voting allows a shareholder to accumulate and cast or vote all of their shares for a single candidate in an election involving more than one director. By employing this process, minority shareholders are more likely to be represented by at least one board director.

Shareholder Activism

To force a firm to act the desired way, shareholders may employ shareholder activism techniques. Increasing shareholder value is an activist shareholder’s primary goal.

Shareholder activism can be done by direct corporate engagement and stewardship to encourage corporate action, forcing management using proxy fights, proposing shareholder resolutions, and publicly disclosing the issues of contention.

Shareholder Litigation

Shareholders can also employ lawsuits. One common type is shareholder derivative lawsuits. Shareholder derivative lawsuits are legal actions brought by one or more shareholders against the board of directors, management, or controlling shareholders. The plaintiff shareholder in these actions is deemed to be acting on behalf of the company in lieu of its directors and officers who have failed to act appropriately in the interest of the firm and its shareholders.

Corporate Takeovers

Corporate takeovers are scenarios in which shareholders of a company hire and fire management to achieve better resource utilization. They can be pursued through a proxy contest where shareholders are persuaded to vote for a group seeking a controlling position on a company’s board. Alternatively, a tender offer strategy can be employed. In this case, shareholders sell their interests directly to the group seeking control of a company. Lastly, a hostile takeover can be resorted to. This refers to an attempt one company makes to acquire another company without the consent of the company’s management.

Creditor Mechanisms

Creditors use many mechanisms to protect their interests in a company. These include:

• Bond indenture: This legal document outlines the components of a bond, a company’s responsibilities, and bondholders’ rights.
• Creditor committees: Once a corporation declares bankruptcy, creditor committees are constituted to represent bondholders throughout the bankruptcy process. Their primary brief is to safeguard bondholder interests in any restructuring or liquidation.

Board of Directors and Management Mechanisms

Company shareholders elect a board of directors to provide oversight to a company. A board of directors appoints the top management of a company, is held accountable by shareholders, and is responsible for the overall governance of a company.

Board Committees

The boards usually assign specific tasks to committees drawn from the board members. The core committees include an audit committee, nominating or governance committee, and a compensation or remuneration committee.

The committees are in charge of considering, monitoring and acting on issues related to their competence. A committee regularly reports to the board and makes recommendations. Typical board committees are:

• Audit committee: The appointment of external auditors, as well as the implementation of high-quality accounting principles, are all overseen by the audit committee. In addition, this committee ensures the accuracy of the financial statements.
• Remuneration or compensation committee: This committee focuses on issues related to compensation. Such issues include defining director and executive remuneration policies, managing the administration, and assessing performance policies. Further, this committee establishes human resources policies regarding employee compensation.
• Nomination committee: It oversees director nominations and elections, identifies candidates for senior leadership positions, and maintains the makeup and independence of a board of directors. It is also concerned with the process of nominating and electing board members.

Additional Committees

Other committees include governance committees, risk committees, investment committees, and other industry-specific committees.

• Risk committee: It helps the board identify a firm’s risk profile and appetite. Besides, it ensures an organization has a suitable enterprise risk management system and coordinates corporate operations with risk appetite.
• Investment committee: It examines and assesses the viability of the vital investment options suggested by the management.
• Governance Committee: The primary responsibility of the governance committee is to ensure that an organization adopts sound corporate governance structures and practices. This enforces compliance with applicable regulations and makes necessary corrections to align the organizational structure to corporate governance principles.

Employee Mechanisms

By managing employee relationships, employers may make sure that their staff members can act in the business’s best interests, meet their obligations to the organization, and have the requisite motivation to serve in their roles efficiently.

Labor Laws

The rights of employees are primarily secured through labor laws. Labor laws define the standards for employees’ rights and responsibilities. The laws cover working hours, pension plans, hiring and firing practices, and vacation and leave entitlements. Unions seek to influence certain matters that affect employees’ well-being in their jobs.

Employment Contracts

Employment contracts specify an employee’s rights and responsibilities. However, they do not cover every situation between employees and employers.

Effective human resource policies seek to attract and recruit high-quality employees. Such policies provide remuneration, training or development, and career growth prospects to improve employee retention. Employee Stock Ownership Plans (ESOPs) are also used to retain and motivate employees.

Companies sometimes use Codes of Ethics and business conduct to establish their values and standards of ethical and legal behavior that employees are expected to follow.

Customer and Supplier Mechanisms

Customers and suppliers of a firm enter into contracts that define the goods and services that underlie the relationship, the costs and terms of payment, the rights and obligations of each party, and any guarantees. Contracts also outline the steps to be followed and available options in the event of a contract breach.

Government Mechanisms

Laws and Regulations

Governments and regulators create regulations that businesses must abide by. In addition, governments keep track of how well the regulations are being followed. A stricter regulatory framework is applied to industries whose services and goods are more likely to put the public at risk.

Corporate Governance Codes

Numerous regulatory bodies have implemented corporate governance codes comprised of guiding principles for publicly listed firms. These codes mandate companies to either reveal their compliance with the suggested corporate governance practices or provide reasons for non-compliance, a method known as the “comply or explain” approach.

For instance, in Japan, companies without external directors must provide a rationale for why the appointment of such directors is not suitable.

Question

Which of the following is most likely a board of a shareholder mechanism used to promote good corporate governance?

1. Bond indenture.
2. Employment contracts.
3. Shareholder derivative lawsuit.

The correct answer is C.

A shareholder derivative lawsuit is a shareholder mechanism used to promote good corporate governance. These are legal actions brought by one or more shareholders against the board of directors, management, or controlling shareholders.

A is incorrect. Bond indentures are credit mechanisms a company’s creditors use to protect their interests in a company. It is a legal document that outlines the components of a bond, a company’s responsibilities, and bondholders’ rights.

B is incorrect. Employment contracts are employee mechanisms used by employees to promote good corporate governance. They specify an employee’s rights and responsibilities in a company.