Who Owns The Corporation

Slide 1: Who owns the corporation? Prof. dr. R. A. M. Pruijm RA

Slide 2: • Emeritus professor Erasmus University • Lector Corporate Governance Fontys • Director Knowledge Centre Finance & Accounting

Slide 3: Content • Why is it so important? • The corporation and its stakeholders • Who is in charge? • Shareholder’s democracy? • Activist shareholders • Conclusion

Slide 4: Who owns the corporation? Why is that important?

Slide 5: Who owns Microsoft? • Market- capitalization: $265 billion • Employees: 80.000

Slide 6: Who owns ABN Amro? • Market capitalization: 71 billion euro • Employees: 107.000 • Who is the owner? – Fortis? – Banco Santander? – Royal Bank of Scotland?

Slide 7: Why is it important? • Corporations are essential for the world economy • How a company operates is important • The purpose of a corporation is important • Who is in charge is important

Slide 8: Largest Public Companies Sales Profit Assets Market Value ExxonMobil 335 40 224 410 General 163 20 697 358 Electric Microsoft 46 12 66 275 Citigroup 146 22 1884 247

Slide 9: What is a corporation? • Corporation derives from the Latin Corpus a “body of people” • A legal entity which has a separate legal personality from its members (shareholders) • To undertake tasks too risky or too expensive for individuals to embark upon • Oldest corporation: Stora Kopparberg mining in Falun, Sweden in 1347 • Other examples: Dutch East India Company and Hudson’s Bay company

Slide 10: Stora Kopparberg share

Slide 11: Dutch East India Company share

Slide 12: Legal characteristics • Own legal personality – An juristic person • Transferable shares – Shareholders can change without affecting its status • Perpetual succession capacity – Continued existence despite shareholders death or withdrawal • Limited liability – For corporate debt, from judgments against the corporation, amnesty from criminal actions of the corporation

Slide 13: Advantages • For the corporation – Easy (equity) capital – Low costs (no dividend obligation, no interest) • For shareholders – Limited risk (as many shares as you want, from different corporations) – Chance of a profitable investment (increase in price of shares, and possible dividend) – Easy exit by selling shares

Slide 15: Corporation • Publicly traded corporation, the shares of which are traded on a public market, e.g. The New York Stock Exchange

Slide 16: Ownership and Control • Persons can have the right to vote or share in the profit of corporations • These voters hold shares of stock and are called shareholders

Slide 17: Ownership and control • Control of the corporation is determined by a board of directors, elected by the shareholders • The board consists of executive and non-executive members • Executive officers are chosen by the board to manage the daily affairs of the corporation

Slide 18: Limited liabiliy • Sharholders are said to have a "residual interest.“ • Should the corporation end its existence, the shareholders are the last to receive its assets, following creditors and others with interests in the corporation. • This can make investment in a corporation risky; however, a diverse investment portfolio minimizes this risk. • Shareholders also receive the benefit of limited liability regulations, making shareholders liable for only the amount they contributed.

Slide 19: Agency problem “Corporate governance deals with the ways in which suppliers of finance to corporations assure themselves of getting a return on their investment … the agency problem” Shleifer & Vishny ‘A survey of corporate governance’, The Journal of Finance (1997)

Slide 20: Agency problem • Separation of Ownership and control Berle & Means, The Modern Corporation and Private Property (1932)

Slide 21: The Agency Problem Agency Relationship Shareholders Risk Bearing Specialist (Principals) (Principal) Hire Firm Owners Managerial Decision- Making Specialist (Agent) Managers (Agents) Decision which creates Makers

Slide 22: Corporate Governance “The directors of such companies, however, being the managers rather of other people's money than of their own, it cannot well be expected, that they should watch over it with the same anxious vigilance with which the partners in a private copartnery frequently watch over their own .... Negligence and profusion, therefore, must always prevail, more or less in the management of the affairs of such a company?” Adam Smith, An Inquiry into the Nature and Causes of The Wealth of Nations (1776)

Slide 23: Corporate Governance “Corporate governance deals with mechanisms by which stakeholders of a corporation exercise control over corporate insiders and management such that their interests are protected. The stakeholders of a corporation include equity- holders, creditors and other claimants who supply capital, as well as other stakeholders such as employees, consumers, suppliers, and the government.” John & Senbet (1998) ‘Corporate governance and board effectiveness’, Journal of Banking &Finance

Slide 24: Corporate Stakeholders Employees Shareholders Corporation Suppliers Consumers Community Lenders

Slide 25: Shareholder power =

Slide 26: Large takeovers • VNU • Euronext en New York Stock Exchange • Rodamco Europe en Unibail • ABN Amro • Stork • But also – ICI door AKZO Nobel

Slide 27: Governance debate • Who is in charge –Directors or shareholders? –Primacy debate • What is the purpose of the corporation? –Shareholder wealth maximization –Stakeholder wealth maximization

Slide 28: Competing Models Who’s in Towards Charge? What End? Stakeholder Managers and Stakeholders theory Directors Shareholder Shareholders Shareholder primacy and Directors wealth maximization

Slide 29: Primacy debate: shareholders • Shareholders are the owners of the company • The residual claims argument • Agency cost argument

Slide 30: Are shareholders the owners? • Most common argument: Milton Friedman in 1970 –The shareholders of the corporation are “the owners of the business’, the only social responsibility of business is to increase its profits.

Slide 31: Misunderstanding

Slide 32: Owners? • Legal entity without owners • Shareholders own stock, not the corporation • As owners of stock their rights are limited • Ownership argument is empirically incorrect, nobody owns the corporation

Slide 33: Residual Claimants? • Shareholders do have an implicit contract that –Entitles them to whatever remains after the firm has met its obligations and paid its fixed claims –According to this claim, firms should be run toward maximizing shareholder wealth

Slide 34: Correct? • Only in bankruptcy • No further entitlement, only when – Directors are able to decide that they should receive a dividend – The firm is doing well enough

Slide 35: Agency costs • Directors are only human – They have fiduciary duties to the constituents of the firm – But they also have their own interests and may shirk or even steal from the firm. – Agency costs can be reduced when one can monitor and measure an agent’s performance.

Slide 36: Result • Stockprice is the only measure that reflects how well directors are doing their job

Slide 37: Empirical evidence?

Slide 38: Lawmakers • Law generally follows the stakeholder model • Corporate directors must serve shareholders and other stakeholders • Business world prefers the stakeholder model • Shareholder value is an important metric

Slide 39: Stakeholder theory • Seeks to achieve a balance of risks and rewards • Fiduciary duties of directors will act in accordance of all the corporate constituencies, primarily for the shareholders • Stakeholder theory is not to challenge the supremacy of the shareholder. It is that the shareholder will be ultimately better off if they allow directors to pursue long-term objectives

Slide 40: Mitigating the Agency Problem • Internal control mechanisms – Independent directors appointed by shareholders – Audited financial statements – Performance–based compensation • External control mechanisms – Managerial labour market – Market for corporate control – Shareholder activism

Slide 41: Shareholder (critical) rights • Put items on the agenda of the meeting of shareholders for discussion • Appointment of non- executive board members • Approval of major decisions • Right of dismissal of all non-executive board members • Approval annual report

Slide 42: Activist shareholders • Barbarians at the gate • Locusts • Corporate raiders • Only short term profit counts • Our companies are being robbed

Slide 43: Examples?

Slide 44: Who are shareholders?

Slide 45: Profile • Most of them are foreign investors: 75% • Most of them are institutional: 70% – Banks – Insurance companies – Pensionfunds – Hedge funds

Slide 46: Example • 87% institutional investors • 13% private investors

Slide 47: Large investors Holding Voting rights ING 10% 2% UBS 3% 5% Fortis 7% 1% Kempen Capital Mgt. 6% 0,3% Eureko 5% 1% Aviva 8% 1% Aegon 6% 0,3% Stichting Prerente Aandelen 41% 2%

Slide 48: The loyal shareholder? Institutional: Holding period 15 months Private investors: Holding period 7 months ABN Amro shareholders: Holding period 13 months

Slide 49: In Perspective 1960 7 years 1992 2 years 2006 7 months

Slide 50: Long-term investment? No. Shareholders are short-term investors

Slide 51: What is a shareholder? • Short-term investor • Focus on short- term profit • Consider companies as a commodity

Slide 52: Implications • Principle of “Shareholder democracy” completely gone • Employees pay the bill

Slide 53: It is all about profit

Slide 54: Shareholder democracy? • Tourists don’t vote! • Gamblers don’t own the casino!

Slide 55: Active voting? Only 40% of the shareholders are present at the annual shareholders meeting of the largest Dutch companies

Slide 56: Trend • Hedge funds like the activist shareholder approach – cheap with a good chance off rich profits – They will not restrict themselves to relatively small investments – Example: Stork (more than 40% controlled by hdge funds) • Sovereign wealth funds – They become large shareholders, driven by (strategic political) interests (3000 billion dollar) – Example: Barclays, Citigroup, Merrill Lynch

Slide 57: Result • New playing field –Limited number of investors with large holdings, and no longer many investors with small holdings –They will dominate in the decision making process without any obligation to buy the company

Slide 58: A shift in power

Slide 59: But More companies went bankrupt through mismangement than by activist shareholders Ruud Pruijm

Slide 60: Conclusion • Nobody owns the corporation • Balance between stakeholders is in danger by increasing shareholder’s dominance • Short-term approach will be prevalent, there are no long-term shareholders anymore • In the end, the employees will pay the bill

Slide 61: CV Prof. Dr. R. A. M. Pruijm CPA is management-consultant, interim- manager and professor emeritus Accounting Information Systems at the Erasmus University Rotterdam. He was recently appointed as part-time lecturer Corporate Governance at the Fontys Professional University. He is a well-known expert in corporate governance, corporate social responsibility, and business ethics. Corporate governance is a generic term that describes the ways in which rights and responsibilities are shared between the various corporate participants, especially the management and the shareholders. Corporate governance is about promoting corporate fairness, transparency and accountability. Corporate social responsibility is about open and transparent business practices, that are based upon ethical values and respect for employees, communities, and the environment, designed to deliver sustainable value to society at large and to shareholders. For over 30 years Professor Pruijm has been speaking to top level business executives and organizations all over the world. He is author of numerous books and articles, and is a regular guest on radio and television. As an independent observer and thought- leader he is frequently consulted by the press, politicians, and business leaders. Office: Kievit 12 -113 5111 HD Baarle Nassau Tel. 013 – 507 03 41 Mobile 06 547 36 391 E-mail: ram.pruijm@ext.eur.nl