Corporate Governance and Stakeholder Management

Stakeholder management emphasizes the need for a company to consider the needs of all its stakeholder groups. It aims at laying 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.

Shareholder Mechanism

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

Corporate Reporting and Transparency

Shareholders can gain a range of financial and non-financial information, mainly through annual reports and other company disclosures. Access to this information reduces information asymmetry between shareholders and managers. In the end, transparency allows shareholders to appraise a company and make informed decisions on company valuations.

Shareholder Meetings

General meetings allow shareholders to participate in company-related discussions and vote on major corporate matters.

Companies usually hold an annual general meeting (AGM) within a certain period of time after the end of their financial year. The main 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 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 amendments to bylaws, 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 his or her shares for a single candidate in an election involving more than one director. By employing this process, minority shareholders have an increased likelihood of being represented by at least one board director.

In order to force a firm to act in the desired way, shareholders may employ shareholder activism techniques. Increasing shareholder value is an activist shareholder’s main goal. This can be done by encouraging pro-active business action or direct corporate participation and stewardship.

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 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 Mechanism

There are a number of mechanisms that creditors use to protect their interests in a company. These include:

• Bond indenture: This is a legal document that outlines the components of a bond, a company’s responsibilities, and bondholders’ rights.
• Corporate reporting and transparency: In order to guarantee that convents are not broken, bondholders demand that a corporation periodically discloses information.
• 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

A board of directors is elected by company shareholders 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. Further, a board dictates the strategic direction of a company, guides and monitors management’s actions towards the execution of company strategy and evaluates management performance. Aside from the aforementioned roles, a board supervises the audit, control, and risk management functions of a company, as well as its compliance with all applicable laws and regulations.

• Board committees: Boards create committees to which they assign specialized tasks within their areas of expertise. These 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.
• Governance Committee: The primary responsibility of the governance committee is to ensure that an organization adopts sound corporate governance structures and practices. This enforces organizational compliance with applicable regulations and makes necessary corrections aimed at aligning the organizational structure to corporate governance principles.
• 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 assessment of 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.
• Risk committee: It helps the board identify a firm’s risk profile and appetite. Besides, it ensures that 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 key investment options suggested by the management.

Employee Mechanisms

By managing employee relationships, employers may make sure that their staff members are capable of acting in the business’s best interests, meeting their obligations to the organization, and having the requisite motivation to efficiently serve in their roles.

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 such matters as working hours, pension plans, hiring and firing practices, besides vacation and leave entitlements. Unions seek to influence certain matters which affect the well-being of employees 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

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.

Question

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

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

The correct answer is C.

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.